Indirect tax considerations and challenges in the UK in 2023

As plans and objectives for 2023 are formulated, this article looks forward to what could be in store for UK VAT in the new year. Some of the challenges were present in 2022; however, with the likely increase in enforcement by the UK tax authority this year, there is potential for particular focus on these areas as part of their investigations as the year progresses.

Making Tax Digital (MTD) for VAT

Building on the updates to MTD for VAT in 2021 (including the need for digital links between compatible software), further requirements took effect in 2022. From 1 November 2022, all businesses, unless one of the limited exceptions is applicable, have been required to sign up for MTD and submit VAT returns using MTD-compatible software. A failure to do so will mean that most businesses that submit VAT returns on a quarterly or monthly basis will be unable to, as the existing VAT online account can no longer be used to submit VAT returns from this date.

The UK tax authority, HM Revenue & Customs, also has recently published details of the penalties they will charge for those businesses that fail to comply with MTD. The penalties range from £100 to £400 for each return filed without compatible software, as well as further penalties of £5 to £15 for each day that digital records aren’t held and digital links aren’t used. As yet it is unclear how these penalties will be assessed or levied.

With the introduction of MTD-specific penalties, it’s likely that HMRC will start to include MTD as a part of their VAT reviews in 2023. Therefore, if they haven’t done so already, businesses are recommended to undertake a review of their VAT compliance processes with a focus on MTD to ensure they are compliant. It is also worth noting that MTD is expanding to include other taxes and sectors. From April, there will be new MTD reporting for landlords with turnover over £10,000.

Exporting goods

Over the last few years, the focus by business usually has been on the treatment of imports; however, exports need equal consideration.

The rules governing exports have not changed but, following Brexit, many businesses would have needed to become acquainted with the distinctions between EC intracommunity supplies (i.e. dispatches) and exports. Prior to Brexit, dispatches could be zero-rated for VAT purposes, provided certain conditions were met, and moved freely within the single market and EU Customs Union. Following Brexit, all shipments leaving the UK are subject to the previous indirect tax rules for exports.

Businesses should be aware that export evidence requirements are quite specific, and it is easy for a layman to mistake supplementary evidence (such as consignment notes and packing lists), with official and commercial evidence (such as airway bills and bills of lading) that are required in order to zero-rate an export.

The retention of export evidence is a primary VAT risk for export businesses. This remains a “hot topic” area for HMRC, which will look at VAT-free exports made by businesses to ensure that all the conditions have been met in order for the business to have adopted that position. To mitigate these risks, businesses should ensure that they have well-documented processes in place which only allow zero-rating to apply when these are held.

Customs duty

Customs duty was once the “forgotten tax” but has become topical over the past two years since the UK left the EU. During 2022, the focus moved to more of a strategic assessment of whether supply chains are optimal and onto duty mitigation strategies, rather than a reactive “Can my goods move?” focus that we’ve seen previously.

Customs data analytics has become increasingly important in helping businesses assess their duty exposure and compliance profile. Unlike VAT that can be recovered, customs duties are usually a sunk cost to a business, but customs special procedures such as inward processing and customs warehousing can help to provide relief from duties in certain circumstances. Management support system data reports can be obtained directly from HMRC and contain details of all customs declarations made. Analysing this data can help businesses understand whether the correct duty has been paid, highlight risks, and identify opportunities such as overpaid customs duties which may be reclaimable.

In 2022, we also saw the introduction of the Customs Declaration Service (CDS) as the sole customs platform for lodging import declarations and, from November, export declarations will also need to made via the CDS instead of the old CHIEF system.

Customs valuation is a critical part of the customs declaration. In the CDS, it is necessary to declare which valuation method (of six) is being used. The “transaction value” method (method one) is used for over 90% of customs declarations and refers to the price paid or payable for the goods. Imports from related parties must also be declared as such, and the use of transfer price mechanisms to inform the customs value in such scenarios is an increasingly complex area.

As mentioned elsewhere in this article, we have seen HMRC compliance audit activity increase recently, and we expect to see this trend continue in 2023.

VAT exemptions

In 2022, we also saw HMRC focus their attention on the medical sector and in particular the exempt treatment of medical testing. Services that are exempt are not taxable for VAT purposes. This has two effects: first, VAT is not charged on the services; and second, VAT incurred on costs directly related to the provision of exempt services is not eligible for recovery.

While the general rule is that a medical service intended to protect, restore, or maintain human health is exempt from VAT, there are some conditions regarding how the service is delivered. When receiving care or treatment outside of a hospital, it is critical to determine whether it is entirely performed or directly supervised by a medical professional on one of the recognized professional registers, as this can determine whether the VAT exemption can apply.

Similarly, in the finance sector, we have noticed a recent trend of HMRC increasing their attention on financial intermediaries and payment processors. Over the last few years, the financial services industry has undergone a major transformation, with a number of new entrants and services in the fintech space.

The VAT treatment of intermediary and payment processing services has been the subject of high-profile VAT case law, which has led to increased HMRC scrutiny on the treatment of such services. In our experience, entities often meet some but not all of the conditions required to fall within exemption.

The medical care and financial services exemptions are applied narrowly and have a series of conditions to be met that have been set out in VAT law and some high-profile litigation. There is also a “cliff edge” in the impact between having to account for VAT at the standard rate of 20% and exempt treatment; the possible addition of 20% VAT either makes supplies more expensive or reduces the supplier’s profit margin. Similarly, getting the VAT treatment wrong can cause unexpected costs at a later date, given there is a four-year lookback period in VAT law. The exempt treatment of services is often a key area of focus for HMRC as well as the courts, and we can safely assume HMRC’s interest in this sector to continue in 2023.

In summary

Last year saw HMRC carry out a targeted approach, for example on those carrying out medical testing services, and this year could see a similar move toward looking at other high profile and high-value sectors, including financial services and land and property. It is important for businesses to carry out internal reviews of both their VAT liabilities and processes to ensure accurate VAT returns are being filed.

For further information or to discuss how we can help you, please contact Robert Marchant or your usual Crowe contact.

This article was first published on Bloomberg Tax Online on 13 January 2023