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HMRC internal manual

VAT Traders’ Records Manual

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HM Revenue & Customs
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Credit and Debit notes: When do Regulation 38 adjustments need to be made to the VAT account?

Regulation 38(5) says:

“Every entry required by this regulation shall, except where paragraph (6) below applies, be made in that part of the VAT account which relates to the prescribed accounting period in which the increase or decrease is given effect in the business accounts of the taxable person.”

The situation in the case of an insolvent trader is covered by paragraph 6 of Regulation 38.

Regulation 38(6) says:

“Any entry required by this regulation to be made in the VAT account of an insolvent person shall be made in that part of the VAT account which relates to the prescribed accounting period in which the supply was made or received.”

The situation in respect of adjustments to the value of supplies of goods of a kind used in missing trader intra-community fraud, which are subject to the reverse charge, is covered by regulation 38A, inserted by SI 2007/1418, regulation 4(c), operative from 1 June 2007.

38A(1) Where regulation 38 applies and -

(a) as a result of an increase in consideration for a supply it becomes one to which section 55A(6) of the Act applies; or

(b) as a result of a decrease in consideration for a supply it ceases to be one to which that section applies,

both the maker, and the recipient, of the supply shall make such entries in the VAT payable portion of their VAT accounts as are necessary to account for that fact

38A(2) Paragraphs (5) and (6) of regulation 38 shall apply to any entry required by this regulation as they apply to any entry required by that regulation.

38A(3) None of the circumstances to which this regulation applies is regarded as giving rise to any application of regulations 34 and 35.

To support the correct treatment of such reverse charge adjustments, regulation 38(1C) was inserted by SI 2007/1418, operative from 1 June 2007.

38(1C) Where an increase or decrease in consideration relates to a supply in respect of which it is for the recipient, on the supplier’s behalf, to account for and pay the tax, the prescribed accounting period referred to in paragraph (1) is that of the recipient, and not the maker, of the supply.

In practical terms this means that, if:

  • a supply is one to which the reverse charge procedure applies;
  • its value changes but, at its revised value, it remains within the reverse charge procedure; and
  • the change takes place after the end of the prescribed period of the customer in which the original supply took place

then the customer adjusts both his output tax and input tax accounts to reflect the revised value.

Alternatively, if:

  • a supply is one to which the reverse charge procedure applies;
  • its value changes and, at its revised value, it is outside the reverse charge procedure; and
  • this change takes place after the prescribed accounting period of the supplier in which the original supply took place

then the supplier adjusts his output tax and the customer adjusts both his output tax and input tax accounts to reflect the revised value.

A new section 26AB to the VAT Act 1994 and new VAT regulations 172K - M cover adjustments to be made by recipients of supplies of goods of a kind used in missing trader intra-community VAT fraud, when they have not paid for the goods within six months of receiving the supply of goods. In such a situation the customer adjusts both his input tax and output tax accounts.

As the supplier and customer may be on different staggers, this means that input tax can be adjusted in a tax period later than that in which output tax is adjusted.

Regulation 38(5) indicates that an adjustment to the VAT account must be made in the accounting period in which the decrease in consideration is given effect in the business accounts. There is no legal definition of the term ‘business accounts’ and therefore the ordinary meaning should be used. This will normally mean when the credit note (or document having a similar effect) is issued and entered in the accounts of the business, but it could mean, for example, when money is repaid by the supplier or received by the customer as reflected in the bank statements or cash book.

Where there is a genuine increase or decrease in the consideration for a supply then that increase or decrease should be given effect in the business accounts as and when the credit or debit notes are issued and received. The case of John Copson (MAN/94/833 (VTD 13335)), concerned a failure to adjust records at the time of receipt of a credit note and whether the taxpayer had the ability to correct the error at a later date - see VATREC13120.

Although this is only a decision of the Tribunal, it does provide some authority for the proposition that a taxpayer is not entitled deliberately to delay giving effect to an increase or decrease in consideration by failing to enter a credit or debit note in his business accounts when it is issued or received.