Don't forget the VAT

It could be assumed that VAT is for Customs & Excise and retailers, and nothing to do with payroll. Wrong, warns Keith Cossey, Macintyre Hudson, Chartered Accountants

VAT is not necessarily the first thought when paying out expenses or when completing P11Ds but it can be very costly if it is ignored.

When completing a P11D the value of any benefit provided to an employee must be shown as the VAT-inclusive cost, even where the employer can legitimately recover the VAT.

The entry on P11Ds showing the use of an asset will be the 'annual value' plus certain running costs, the annual being 20% of the cost of the asset. If the cost price is taken from the fixed assets register or purchase ledger, it is probable that the value will normally be net of any VAT that the business has recovered.

If the VAT-exclusive value is used, the benefit will be understated and may be missed altogether.

Taking the example of a laptop computer costing £2,495, then 20% of this cost comes to £499 and as such is below the £500 exemption threshold relating to computer equipment (assuming no other computer or related equipment is provided). However if £2,495 were a VAT-exclusive price, the cost of the asset would be £2,931.63 (£2,495 + £436.63 VAT). The 20% annual value would now be £586.33, and since this is above the £500 exemption limit it potentially gives rise to a taxable benefit.

When deciding which staff require a completed P11D, the £8,500 threshold has to be considered. If it is not, problems will arise. Last tax year an employer felt that P11Ds were not required for a group of part-time employees because their wages benefits and reimbursed expenses for the year fell between £8,350 and £8,450.

However some of the workers attended the Christmas party, which cost £47 per head. When this cost was added to the part-timers' pay, they still fell below the £8,500 threshold. Unfortunately the £47 excluded the £8.22 VAT recovered by the employer. When this VAT was included it took several employees over the threshold, giving rise to a P11D requirement.

Another common area where incorrect amounts are declared on P11Ds is the reporting of the benefit of providing a home telephone or internet connection. Again, the VAT-inclusive cost of line rental, together with any personal calls paid by the employer, should be declared.

As most readers will appreciate, showing an incorrect benefit or expense on a P11D, or failing to complete a form when one is due, can be a costly exercise. There are penalties for failure to submit P11Ds, for the submission of incorrect forms and the further complications now associated with Class 1A NICs. Ignoring VAT can also be costly, since many employers often fail to recover VAT incurred by or in connection with employees.

VAT incurred on employee entertaining such as Christmas dinners or parties is recoverable. For example, if the VAT-inclusive cost of the event comes to £100 per person, £14.89 per employee (100 x 7/47) can be recovered if the employer is VAT registered. Do note, however, that no VAT can be recovered on the cost of guests or relatives of the employees attending the party.

While on the subject of Christmas, VAT can generally be recovered on small gifts given to employees or businesses contacts provided that the cost of each gift or series of gifts does not cost more than £50 (including VAT) per recipient per year.

When employees work away on business any VAT on their subsistence and/or accommodation costs is recoverable. If their spouse or partner goes with them only the VAT relating to the employee can be recovered.

Non UK VAT may also be recoverable in respect of employees who stay overnight in another European Union state (if VAT is recoverable under the host state's VAT legislation). The problem is that the claim has to be made to the host country and in their language. If there are regular visits to the same EU country it could be worth looking in to.

Where fuel is provided to employees for use in company cars, VAT may be recovered in full on the cost, however a VAT scale benefit charge must also be paid to account for private use.

In many cases the VAT scale charge can be more than the amount recoverable and employers can choose not to claim back the VAT on their fuel and should notify Customs & Excise that they are not so doing, otherwise the VAT scale charge will still apply.

Where an employer reimburses employees for business mileage incurred by both company car and owner-drivers, Customs & Excise will allow the employer to recover VAT on the mileage rate paid. They will accept as a benchmark the Inland Revenue's advisory mileage rates for company cars (see www.inlandrevenue.gov.uk/cars/fuel_company_cars.htm for the current rates) as being inclusive of VAT and allow VAT recovery where the rates are used. The Inland Revenue Authorised Mileage rates can't be used as they include an element of depreciation, car tax and insurance all of which are non-VAT-able.

If an error has arisen in the payment or recovery of VAT the position can and should be rectified by way of a voluntary disclosure to Customs & Excise. Current capping legislation only allows errors to only be corrected if they are less than three years old. Errors over three years old are likely to be out of time.

The amount of unclaimed VAT can often be much higher than the cost of correcting the error, making correction worthwhile. Applying the correct procedures now could give substantial savings in the future.

• Look out for our P11D supplement with the February issue of Payroll World.

• Omitting the VAT element of a benefit can lead to mistakes on testing if a key threshold is breached
• VAT can be recovered for certain benefits, but care must be taken, and it is strictly only for employees, never partners or friends
• Errors on VAT can be rectified within a three-year time limit