When VAT was introduced in the 1970s it was described as a ‘simple tax’.
For many farming businesses, this remains broadly true, particularly where income consists primarily of zero-rated supplies such as crops and livestock.
In these cases, VAT on related costs can generally be reclaimed in full.
However, diversification has introduced greater complexity, and many modern farm businesses now generate a mix of income streams requiring different VAT treatments.
There are five key areas to consider:
Link between expenditure and taxable supplies
In order for VAT to be reclaimed on any expenditure, a business must show that there is a direct link to taxable supplies made by the business.
Taxable supplies cover most sales made by a farming business, including livestock, crops and machinery sales, but crucially not subsidy income, which is outside the scope of VAT.
Requirement for activity
VAT registration requires the existence of a genuine business activity carried on with a degree of commerciality.
In one case, a farming business had reduced its activities over the years but continued to submit VAT returns and reclaim expenses, including the cost of a new building. Its only income was £440 from hay sales to a connected business.
HMRC argued that the business was not being carried out on a commercial basis and that it should be deregistered.
The tribunal agreed with HMRC, and the business had to repay £19,720 of VAT.
VAT treatment of connected businesses
HMRC has powers to deem connected businesses as a single business for VAT purposes. The risk in this area is where spouses operate the separate ventures.
This situation can arise with a bed and breakfast or holiday letting business.
The income of both these businesses is standard-rated, meaning that if they are run as part of the VAT-registered farming business, the 20% VAT has to be paid over.
This may not be the case if the diversified ventures are kept totally separate, but care needs to be taken in this area.
Property letting and partial exemption
Rental income from land or property is generally exempt from VAT.
The default position is that as rent is an exempt supply, VAT cannot be reclaimed on related expenses such as the cost of refurbishing a cottage that is let out.
There is a relaxation of this rule, known as partial exemption, if your business makes both taxable and exempt supplies and incurs VAT on costs related to both, for example, where a farming business has significant farming activities and a small amount of rental income and expenses.
You can recover input tax related to exempt supplies if those amounts are within the de minimis limit – this is £625 a month on average and is no more than half the total input tax incurred. The rules here are complex, so again, care needs to be taken.
VAT recovery on cars and commercial vehicles
The VAT treatment of vehicles depends on whether they are classed as cars or commercial vehicles.
This is based on factors such as the presence of rear seats or windows, weight, payload and design.
Input VAT on commercial vehicles is generally recoverable, subject to adjustments for private use.
If the vehicle is classed as a car, recovery of VAT is much more difficult. It is necessary to show that the vehicle is exclusively used for business purposes and is not available for private use. This is not easy to prove in a family business.
Despite its introduction as a simple tax, over the last 50 years, ensuring VAT compliance has come to require careful consideration, particularly where farming activities have diversified and can materially affect VAT recovery and liabilities.
It is therefore important to address these issues to avoid unexpected costs or enquiries from HMRC.
