Family loyalty: is your generosity causing a VAT problem?

Supply of services

For the supplies of advertising services, you and your relative are likely to adopt one of two models:

1. Your business will have a letter of engagement and contract with the supplier and they will invoice you for the work they have done to promote your relative’s business. You will pay the invoices to the supplier and might recharge your relative a token amount.
2. The supplier will directly have a contract with your relative and issue invoices to them but you will settle the bills by paying the supplier.

In the second case, you cannot claim input tax on the invoices from the supplier because the supply of services is from the supplier to your relative. The contract confirms this is the case and this outcome would not change if the supplier addressed its invoices to your business instead.

Tip. In this situation, your payment of the invoices is effectively a donation to your relative’s business unless they will repay you later, so it is a loan.

Trap. As well as not claiming input tax , you should also exclude the payments to the supplier from the Box 6 inputs figure on your returns because they are not your expenses.

Non-business activity

If the supplier invoices your business because you have a contract in place with them, you will still be blocked from claiming input tax, even if you make a token recharge to your relative for costs incurred. This is because the supplier’s invoices do not relate to a “business supply” made by your business. The legislation is clear that input tax can only be reclaimed if it relates to a supply made for the purpose of your business.

If you have any doubt about whether you are making a business supply, you should consider two questions published in HMRC’s guidance:

• Does the activity result in a supply of goods or services for a consideration?
• Is the supply made for the purpose of obtaining income?

Tip. You need to answer “yes” to both of these questions. A token charge will clearly fail the second question.

HMRC powers

You might think that charging your relative a higher recharge fee, perhaps only 20% below cost, might overcome the second question about “obtaining income”. However, HMRC has the power to act if a recharge is made to a connected party that is less than the open market value of the supply, by using the valuation legislation. Broadly:

• it can issue an assessment for output tax based on the open market value of the supply less the value of the recharge to your relative
• it can only do this if your relative would not be able to fully claim input tax on their own returns, either because they are not registered or they make exempt or non-business supplies
• the definition of connected parties includes all close relatives - brothers, sisters, ancestor or lineal descendants. It excludes nephews, nieces, uncles or aunts.

Tip. HMRC’s guidance recognises that it can often be difficult to establish the open market value of a supply to a connected party, so it refers to output tax being “valued at no less than the cost actually incurred by the supplier.”