Understanding the VAT traps on deregistration

There are multiple reasons why organisations will deregister from VAT. Normally, generating taxable revenues under the deregistration threshold of £83,000, or on the wind up of a business give rise to this. Deregistering from VAT should end an organisation’s requirements to administer and account for VAT. However, there can be circumstances where the act of deregistering triggers an obligation to account for additional VAT, leading to unexpected costs.

Deemed supplies

The most common situation where a deemed supply VAT cost arises on deregistration, is in relation to commercial property that is subject to an option to tax.

Commercial property is commonly opted (i.e. an election has been made to waive exemption) to allow input tax in relation to the property to be recovered. On deregistration, many will choose to retain those properties, either for a different use or to wait to sell them at a later time. Unfortunately, the retention of the property at the time of deregistration brings about a VAT charge on the basis that the deregistration creates a deemed disposal for VAT purposes. That VAT charge is based on the market value of the property at the point of deregistration and can result in costly bills for those who weren’t aware, particularly where the value of the property has increased over time.

There may be ways to mitigate the potential VAT costs but they require consideration ahead of the deregistration being carried out. Therefore, it is important to ensure that the VAT consequences of opted property are looked at before a deregistration application is made.

Capital Goods Scheme

Another potential pitfall exists in relation to the Capital Goods Scheme (CGS). The most common application of the CGS is in relation to commercial property purchases and refurbishments, but it can also apply to other assets including computer equipment and aircraft, ships and boats. By way of brief background, the CGS requires the level of VAT recovery on the asset to be considered over an extended period. If the way in which the asset is used changes an adjustment to the VAT recovered can be required. Deregistering from VAT will bring the CGS adjustment period to an early end, potentially requiring a clawback of VAT over reclaimed.

Here is a simple example of the unexpected VAT costs that can arise on deregistration. An organisation acquires a property for which £100,000 of VAT was incurred on acquisition. The property was used as a trading premises in a fully taxable business and so was not subject to an option to tax. After eight years a decision is taken for the organisation to deregister from VAT. As property within the CGS has a ten year adjustment period, there are two years of CGS adjustments remaining which VAT law would deem to be exempt use. This would result in an output tax charge of £20,000 as the asset is linked to an exempt supply on deregistration.

In such instances, recognising the length of time left on qualifying assets and their use within the organisation can be a useful exercise before deregistering to ensure that organisations aren’t caught out by this complex area of VAT.

Stock and asset on hand at deregistration

If an organisation has stock and assets still on hand at the date of deregistration on which VAT was reclaimed, then it may need to account for VAT on a deemed supply of those assets as part of the deregistration process. This can be costly where an organisation has a large volume of stock left unsold or business assets it intends to utilise after the deregistration.

Organisations should be aware that there is a de minimis level below which no deemed supplies stake place. No output tax is due where the total VAT payable is less than £1,000. Output tax is also calculated on the current market value of those goods at the time of deregistration, which can often be different to the market value of the goods when they were first acquired.

When carrying out this calculation, organisations should ignore goods and assets where VAT was not claimed or those goods were zero-rated or exempt when purchased.

Consider whether a deregistration is the most beneficial option

It’s important to understand the pitfalls that can be associated with deregistering and proper planning prior to an application can avoid a number of costly issues.

However, if the decision to deregister is the result of the desire to remove the administration burden on compliance such as Making Tax Digital (MTD), we would also recommend that appointing us as tax advisors to help, who can advise whether a deregistration is the best option at the time, laying out all of the options available and making VAT compliance a simpler task each quarter. This can also involve appropriate tax planning that mitigates the cost of deregistration, takes into consideration the issues set out above and leaves organisations confident in the fact that there are no hidden surprises.