Why Can’t I recover VAT on Business Invoices?

The most asked question we hear from businesses is why they can’t recover VAT on costs they incur.  In many cases the reason is obvious and is likely to be because the VAT rules specifically don’t allow VAT recovery – an example of this would be VAT incurred on business entertainment which is blocked.  Another reason is that the business does not hold the correct evidence to recover the VAT.  Where a business does not have a valid VAT invoice it is unlikely that the tax authorities (in the UK this is HM Revenue & Customs or “HMRC”) would allow VAT recovery.      

Sometimes the reason for lack of VAT recovery is less clear.  A scenario which we are seeing more often is a case where a business has purchased goods or services and holds a proper VAT invoice on which VAT at the standard rate is shown.  As occurs from time-to-time HMRC undertake a VAT audit and ask to see some or all of the purchase invoices.   After inspecting the invoices, we have seen cases where HMRC have refused to allow the business to recover the VAT because the supplier should not have charged it in the first place. 

Most people are confused by this.  Surely if a supplier charges VAT and shows the VAT on the invoice, a customer should be entitled to recover the VAT in full.  Herein lies the issue – was VAT properly chargeable in the first place?  We have seen many cases where if the supplier has charged the wrong rate of VAT, HMRC does not allow the customer to recover the VAT.  The following example demonstrates this. 

Between July 2020 and the end of September 2021, the UK Government introduced a reduced VAT rate of 5% for certain supplies relating to hospitality and hotel accommodation.  Between October 2021 and the end of March 2022 the VAT rate increased to 12.5%.  During this period, when lockdown rules eased many businesses held staff team building events which qualified for the reduced rate of VAT.  Some suppliers were either unaware of the VAT rate change or their systems were unable to cope with it, so continued to charge VAT at the standard rate of 20%.  Businesses had the mistaken belief that if the supplier pays over the VAT to HMRC and the customer recovers the same amount, it surely shouldn’t matter if the 20%, 5% or 12.5% VAT rate is used, because there is no loss of VAT to HMRC since it nets down to zero. 

Unfortunately for the business in question HMRC didn’t see things the same way and refused the business the right to recover 20% VAT when only 5% VAT should have been recovered.  In HMRC’s view, the customer was required to go back to the supplier and obtain a VAT credit note and refund for the 15% – the difference between the standard rate and reduced rate of VAT.  In most cases this is a mere administrative inconvenience.  The sting in the tail came when the supplier – a restaurant had ceased trading and was in liquidation.  In such a case the customer was unable to go back to the supplier and obtain a refund.  The end result was that the customer was assessed by HMRC for the 15% difference in VAT rates which proved an additional cost. 

The lesson is clear – just because an invoice looks correct you still need to check that VAT was properly charged.  If not, don’t pay it and insist that the supplier charges the correct amount of VAT.  If you wait until after you have paid it may be too late!