Making Tax Digital – Understanding the turnover exemption

Making Tax Digital – Understanding the turnover exemption

CIOT's Richard Wild clarifies just who is eligible for exemption from MTD - after HMRC revealed that around two-thirds of exemption applications to date have been from businesses with turnover below the VAT threshold

Making Tax Digital – Understanding the turnover exemption

You may have thought that the exemption from MTD due to turnover was pretty straight forward – if the business’s ‘taxable turnover’ is below the VAT registration threshold, then it does not have to comply with the requirements of MTD – though it can of course do so voluntarily.

But there is clearly some confusion because, according to HMRC, around two-thirds of exemption applications to date have been from businesses with turnover below the VAT threshold.

So, let’s take a closer look at the rules, and how they should be applied.

The relevant part of the VAT Regulations reads as follows:

32B Exemption from the electronic recording requirements

 (2) This paragraph applies if, for any month (“the current month”), the value of a taxable person’s taxable supplies, in the period of one year ending with the month before the current month, was less than the VAT threshold. The “VAT threshold” has the meaning given in paragraph 6(9) of Schedule 11 to the Act.

(3) Where paragraph (2) applies to a taxable person for the current month and has not ceased to apply for any month prior to the current month then the requirements of regulation 32A shall not apply to that person.

(4) In a case where paragraph (2) ceases to apply to a taxable person, the requirements of regulation 32A shall apply from the beginning of that person’s next taxable period falling on or after the day on which that application ceases.

So in essence, the exemption works in a similar way to the backward-looking test for VAT registration,  i.e. by looking at the value of taxable supplies on a rolling twelve month basis (though see later for an exception to this). The first requirement to undertake that backward-looking test for MTD purposes is for the year to 31 March 2019 for businesses on stagger one or which complete monthly VAT returns (or 30 September 2019 for deferred businesses). If the value of taxable supplies is below the VAT threshold (currently £85,000), then the business is exempt from the requirements of MTD.

If the business is exempt on turnover grounds, it need not apply for exemption from MTD – it is automatic. Even if another exemption might also apply, such as due to a disability, there is no benefit in applying for exemption on those alternative grounds now as HMRC will simply state that the business is below the VAT threshold and need not comply. This is because the grounds for the other exemption will need to be considered at the point the requirements to comply with MTD crystallise.

So, what could be causing the confusion? There are probably three likely candidates:

  1. Understanding what constitutes taxable turnover
  2. Businesses operating just over the VAT threshold
  3. Unclear guidance and communications

Understanding what constitutes taxable turnover

We all know that ‘taxable turnover’, for VAT registration purposes, includes standard rated, reduced rated and zero rated supplies. But there are some quirks:

  1. The value of reverse charge supplies (ie supplies of services from overseas suppliers which are treated as taking place in the UK) also counts towards the VAT and MTD threshold. These include advertising, many professional and similar services.
  2. Unlike the rules for VAT registration, one-off increases in turnover such as disposals of capital assets or are not ignored when considering the rules for exemption from MTD. This doesn’t matter too much if you are not already VAT registered, as you would remain unregistered and so outside the scope of MTD anyway. However, if you are voluntarily VAT registered, a one-off increase in turnover might take you over the VAT threshold of £85,000, meaning you will need to comply with MTD from the beginning of your next VAT return period.
  3. Supplies which are subject to a domestic reverse charge (ie where supplied between two UK parties), such as wholesale supplies of gas and electricity and wholesale supplies of telecommunication services, will also usually count towards the VAT threshold; although these types of supply are not usually undertaken by small businesses. Fortunately, the value of supplies within the new domestic reverse charge for certain supplies of construction services, which comes into effect from 1 October 2019, will not count towards the VAT or MTD threshold.
  4. Supplies which are outside the scope of UK VAT do not count towards the VAT or MTD threshold either. These include supplies which are treated as taking place outside the UK (such as supplies of some services to non-UK businesses), and income which is outside the scope of VAT altogether (such as donations).

Businesses operating just over the VAT threshold

If, when you registered for VAT, you started adding VAT on top of your prices, then the position is likely to be quite straight forward. The value of your taxable supplies will be easily discernible and, unless your turnover falls, will remain over the VAT threshold.

However, the position is rather odd for retailers and those businesses who absorb some or all of the VAT in their prices. This is best illustrated by way of an example.

Let’s say a retailer starts trading on 1 April 2017 and has taxable turnover of £8,000 every month. After eleven months of trading it would exceed the VAT registration threshold and so would be required to notify HMRC of that fact by 31 March 2018 and would be registered for VAT with effect from 1 April 2018. However, let’s assume that the retailer does not adjust its prices, and that all products sold are standard rated. As a result of being VAT registered, the retailer’s taxable turnover becomes £6,666 per month (£8,000, less the VAT element at 1/6). On an annualised basis this amounts to £79,992 ie below the VAT threshold. So, even though the retailer became compulsorily VAT registered with effect from 1 April 2018, if the turnover remains at these levels then it will remain exempt from MTD on turnover grounds because its taxable turnover is below £85,000 in the year to 31 March 2019.

As an aside, could the retailer then deregister from VAT as its taxable turnover is below the deregistration threshold of £83,000? Unfortunately not. HMRC will not allow this unless the retailer can satisfy HMRC that it will reduce its prices by the VAT element (Notice 700/11, paragraph 3.2). Otherwise, the business would be in some sort of strange loop whereby it registers for VAT, but almost immediately become eligible for deregistration.

Unclear guidance and communications

The first iteration of VAT Notice 700/22 included some potentially misleading text. Paragraph 2.1 of the Notice originally read “Only businesses with taxable turnover that has never exceeded the VAT registration threshold (currently £85,000) will be exempt from Making Tax Digital.” As explained above, that is incorrect, and the notice has since been corrected. However, this has caused some confusion, but just to confirm; businesses whose taxable turnover previously exceeded £85,000 per annum, but is below that level at the point they would otherwise be required to comply, are exempt from MTD.

HMRC has also written to all businesses who it thinks might be within the scope of MTD, to raise their awareness of it. For many businesses, it is not immediately clear to HMRC from the VAT returns whether the taxable turnover is above the VAT threshold. For example, box 6 might report a mixture of standard rated, zero rated and exempt supplies. Also, ‘netting up’ the output tax declared in box 1 would not give an accurate result. Because of this, HMRC used a number of differently worded letters, depending upon whether or not they were confident that the business’s taxable turnover exceeded £85,000. Where HMRC were not confident, the letter would be more informative than instructive.

So, it would be perfectly normal for businesses to have received a letter from HMRC, to raise their awareness of MTD, even if they aren’t required to comply. Those businesses are not required to take any further action, although the letters did not make that clear, and so could have caused much of the unnecessary HMRC contact.

So to avoid further confusion…

  1. Check what constitutes taxable turnover for MTD purposes. This might include income / transactions that you weren’t expecting, or exclude those you were expecting to include.
  2. If the business is VAT registered, but has a VAT-inclusive turnover below around £102,000 per annum, then it might still have a taxable turnover below £85,000.
  3. If taxable turnover is below the VAT threshold, then the business need not comply with MTD, and it need not seek exemption from HMRC.

Richard is the Head of the Tax Technical Team at The Chartered Institute of Taxation. His tax career has spanned more than 20 years, mainly in indirect taxes, including roles in a Big 4 litigation team, and as an anti-avoidance adviser with HMRC. Richard joined the CIOT in November 2015, and heads up the team of technical officers who work across a wide range of taxes.

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