Taking a deposit
Many businesses take deposits in the course of their trade and it’s surprising how many get the VAT account wrong. When HMRC inspects a business’ records it checks that VAT on deposits has been accounted for at the correct time.
There are two basic types of deposit. Firstly, where a business undertakes work for a customer and asks for part payment in advance. This is common in the building industry, and suppliers of fitted kitchens and double glazing.
The second type is often referred to as a security deposit. This is where a business takes a deposit against the safe return of goods. For example, a hire shop hires tools and takes a deposit which is returnable when the tools are returned in good condition. If the goods are not returned or are damaged, the deposit is forfeited and kept by the hire shop.
A tax point is created at the earliest of the supply of goods/services, i.e. the receipt of payment or the issue of an invoice. A deposit that represents part payment for a supply therefore creates a tax point, even if it’s refundable if the order is cancelled. This means that VAT is due on the receipt of a deposit that represents part payment for a supply at the time it is received, not when the supply is actually made.
A kitchen fitting business sells a kitchen to a customer for £10,000 and asks for a 20% deposit of £2,000. The order is placed in March 2017 and the deposit paid when the order is made. The kitchen is fitted and invoiced in April 2017 and the final payment received in May 2017. VAT is due on the £2,000 deposit in March and the balance of £8,000 in April when the supply is completed and the invoice issued. A common error is to account for the VAT in May when the final payment is made; this can mean the VAT is accounted for late – attracting interest
Tip. If your business receives deposits it should ask for it by means of a letter to the customer or a request for payment and not by issuing an invoice. If it issues an invoice in advance of receiving the deposit it would be required to account for the VAT at this earlier stage. By not issuing an invoice until the deposit has been received, VAT is not due until you have actually received the money.
The only circumstances in which a deposit does not create a tax point is when it is always intended that the full amount shall be returned to the customer, i.e. a security deposit. You don’t have to account for VAT if the deposit is either:
- refunded in full to the customer when they return the goods safely; or
- kept by you to compensate you for loss or damage.
This is because there is no supply of goods or services when you take the deposit, and if you keep it because the goods are not returned or damaged it represents compensation which is outside the scope of VAT.
Reproduced with the permission of Indicator – FL Memo Limited. For subscription information call 01233 653500;