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Vat Tips - Parts and Labour

 By

SteveAllen

Sadly Steve Allen died in July 2011. His wife Leah would like to thank all those who know Steve and helped contribute to his success. She has recommends Steve's clients and anyone who is interested in this article topic to contact Rob McCann from “The Vat people” on (tel) 0161 477 6600 . Please make reference to Steve Allen.


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Clients sometimes ask what sort of checks HMRC make when they come to visit, as they sometimes ask for documents that you wouldn’t normally expect.

Apart from the usual checks on annual accounts, purchase and sales records etc, HMRC also have a number of specialised checks they carry out on certain business sectors. These checks are useful to HMRC, but they rely on ratios and extrapolation of the results. This is not always good for the taxpayer, as the results can be inaccurate, particularly if HMRC do not have all the information available, and can cost time and money for you to sort out. So it may be useful to know how these checks work, so that you can spot them if HMRC use them on you, and can make sure that they get the right information.

One of the most popular of these checks is referred to as ‘parts and labour’ by HMRC. This is how it works; Businesses that predominantly undertake repair work supply their customers with a mixture of spare parts and the labour costs of fitting them (e.g. garages and electrical repair specialists). In most cases, the invoices they issue split the total charge between the costs of the parts, including mark-up, and the labour costs.

HMRC will look at a sample of sales invoices, add up the total of the parts and the total of the labour, and work out the ratio of the two. They will then look at a sample of the purchase invoices for the parts, and establish the sale price so that they can arrive at a mark-up. They should do this for each line, and work out what is known as a ‘weighted mark-up’ that takes account of the proportion of sales for each line. Having achieved a mark-up figure, they will then mark-up the parts purchases for a period (e.g. VAT quarter or year) to give an expected sales figure for the parts. They will then apply the ratio of the parts and labour to give an expected sales figure for the period. If this is markedly different from the figures on your VAT return, HMRC will likely give you a bill for the difference, which is something you don’t want, of course.

Example:

Sales invoices Total sale of parts = £5,000 Total labour charges = £25,000

Ratio of labour to parts= 5:1 (25,000/5,000 = 5)

Purchase invoices Total parts purchases = £4,000 Weighted mark-up = 45%

Expected sale of parts = £5,800 (4,000 + 45%)

Total expected sales = £34,800 (5,800 x 5 + 5,800)

In the example, if the invoices show sales of £30,000, but the part and labour exercise show expected sales of £34,800, HMRC will bill you for the VAT on £4,800!

So then, if HMRC carry out a parts and labour check, what can you do to make sure you don’t get a bill? The first thing you could do is not separate the part and labour elements on the invoice, but this is not usually commercially possible. However, you can check up on HMRC to make sure they are taking everything into account. In one Tribunal case, it was found that HMRC had added delivery notes into the purchases, making the total purchase figure over-inflated. Sometimes, HMRC forget to take account of stock figures - an increase in stock can have a big effect in this type of exercise. In some cases, HMRC take a short-cut, and don’t do a weighted mark-up, merely a simple average mark-up that can reduce the accuracy of their calculations.

Tip Make sure your records are in good order before HMRC visit, and separate out delivery notes, pro-formas etc., so there can be no mix-ups. If you think HMRC is doing a parts and labour exercise, make sure they know if stock levels have increased (you may have bought an item, but if you haven’t sold it yet, they can’t include it in their calculations). If, after completing their checks, they challenge what you have declared, tell them you know what they have been doing, and ask if they have done a weighted mark-up, or taken into account wastage and stock level changes etc.


About the Author

STEVE ALLEN is the Managing Director of VAT Advisers Ltd, and has more than 19 years’ experience in VAT. Beginning with HM Customs & Excise in 1990, Steve spent 8 years in the Department in a variety of roles such as VAT Insolvency and VAT investigation in Liverpool, and latterly as a VAT Inspector at Wigan VAT Office.

Steve left the Department in 1998 to become a consultant with Latham Crossley and Davies, before joining Ernst & Young. In 2001, Steve formed VAT Solutions (UK) Ltd with a co-Director, and built up a successful practice over 8 years before setting up VAT Advisers Ltd in September 2009.

Steve advises accountants and individual businesses on all aspects of VAT, but in particular, issues concerned with land and property, charities, cross-border trading, and arrears of VAT.

VAT Advisers Ltd,
1 Dundonald Avenue
Stockton Heath
Warrington
WA4 6JT
(t) 01925 212244
(f) 01925 212255
(m) 07810 433927
www.vat-advisers.com



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Article Published/Sorted/Amended on Scopulus 2009-12-10 01:20:03 in Tax Articles

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