Practical guide: VAT savings with a margin scheme

Growing markets

A lot of sales made by small businesses are made via eBay and similar trading sites and often relate to second-hand goods. Hopefully, you will not need to worry about VAT because the total sales will be less than the annual registration threshold of £85,000. But what if you are already registered for VAT and need to account for tax on these sales? The best solution will be to use a margin scheme, where VAT is payable on the profit margin in most cases rather than the selling price.

If you are registered for VAT and trade online as a secondary activity, it might be practical to do this by forming a separate legal entity. This entity will then have annual sales of less than £85,000, so will not need to register for VAT. But everything must be kept separate: accounting records, purchase invoices, bank accounts, tax returns, overheads, etc.

Basic scheme rules

The second-hand margin scheme has always been an important part of the legislation, particularly for businesses that are antique dealers or second-hand car traders, as well as those who deal with works of art and collectors’ items. As far as VAT registration is concerned, it is the sales value that is relevant, rather than the profit margin. The exception to this statement is the tour operators margin scheme but that relates to sales of services rather than goods.

The chance for you to account for output tax on their profit margin rather than the full selling price is a generous concession; the record keeping requirements for second-hand traders are therefore very strict and have legal force.

In the case of a margin scheme trader selling goods at a loss, there is no loss relief to claim, e.g. where the profit on item A can be offset against a loss on Item B. The loss on item B produces a nil VAT liability. However, see the section below about the global accounting scheme.

Goods purchased with VAT charged on the full price by the seller must be excluded from the margin scheme, i.e. normal VAT accounting will apply to these items.

You must keep a stock book to show the purchase and selling price of each item you buy and sell and there are also strict invoicing requirements to be met. The exception is if the items are purchased for less than £500, which means that the global accounting scheme can be used. You must understand that if the margin scheme conditions are not met, HMRC has the power to assess output tax on the full selling price of the goods, assuming they are not zero-rated or exempt.

As far as VAT returns are concerned, the entry in Box 6 (outputs) will be for the full selling price, less any VAT payable with the margin scheme. The purchase price will be included in Box 7 (inputs) and the VAT payable in Box 1.

Overheads are excluded

When you calculate your profit for margin scheme purposes, you must exclude all costs you incur to improve, repair or alter the items before they are sold, e.g. a restorer’s fee for improving an antique piece of furniture.

However, input tax can still be claimed in the normal way if a supplier is registered for VAT and issues a proper tax invoice. This is a key feature of any margin scheme, namely that overhead items are treated separately; there is no addition to the purchase price for the goods.

Example. Marie is an antique dealer and purchased an antique table for £100. She paid a restorer £600 to repair and varnish the table to make it suitable for sale online. The restorer is not VAT registered. Marie sold the table for £1,600. Marie’s output tax liability is £250, i.e. £1,500 x 1/6. Her profit margin is treated as being inclusive of 20% VAT. She cannot reduce her margin by £600 in relation to the restorer’s fee. However, if the restorer had been VAT registered and charged 20% VAT, then Marie could have claimed input tax of £120.

You must keep your accounting records for six years in the usual way. However, you have to keep records until you sell the item for any stock you bought more than six years ago that you plan to sell under the margin scheme.

Global accounting scheme

How do you account for VAT if you sell second-hand goods through an online marketplace, such as eBay? In most cases, the goods you sell will be items of small value and will be purchased from non-VAT registered suppliers, usually private individuals, or registered suppliers also using a margin scheme.

It would be impractical to keep a stock book to record every item that is bought and sold, e.g. some items might be traded for less than £5. This is where the global accounting scheme becomes relevant, which is useful for any business selling a high volume of second-hand goods at low prices. It is described by HMRC as a simplified margin scheme.

The scheme does not apply to any goods that are bought for more than £500, unless goods are broken down into smaller components and sold and the individual items cost less than £500, e.g. a car being broken up by a salvage business. The main features of the scheme are:

• VAT is declared on a return based on the total margin for the period, i.e. “total eligible sales” compared to “total eligible purchases”. So, the scheme gives loss relief on any items sold below cost price.
• The scheme is also a winner for businesses that are increasing their stock because the “total purchases” figure is not adjusted for opening or closing stock. But a business leaving the scheme must make a final adjustment for closing stock to reduce the “purchases” figure.
• The record keeping requirements are less stringent than with the main margin scheme, e.g. no stock book is needed. You only need to issue tax invoices to buyers who are also VAT registered dealers.

If a VAT period produces an overall loss, i.e. with purchases exceeding sales, the loss can be carried forward and offset against future profits. Also, if you have stock items that cannot be sold, e.g. items stolen, broken or damaged, then the original purchase price of these goods must be removed from the total purchase figure for that period.

Dealing with HMRC

What happens if HMRC is not happy with the records kept? Will the officer go back four years and assess tax based on selling prices rather than margins?

The answer is that officers have the power to take this action. However, they should firstly consider if they think that VAT has been underpaid as a result of poor record keeping. If they are satisfied that tax has been correctly paid, they will hopefully issue a written direction about future record keeping and use their discretion to accept past declarations as correct. Even if they are not happy with the declarations, they should give you enough time to bring the records up to standard.

If an HMRC officer challenges your records, the guidance at VATMARG10000 may be useful to cite: “If the non-compliance is serious or you are unable to verify the margin, consider if there are any reasons to assess immediately, such as time limits. If not, give the trader the opportunity to reconstruct the records and warn that failure to do so may result in VAT being assessed on the full selling price of the goods. The trader is always to be given a reasonable amount of time to reconstruct the records; but in any event no longer than three months should be allowed.”