Pub or restaurant? VAT is the question
The Harrow Inn used the VAT Flat Rate Scheme for small businesses to account for VAT using a flat rate applied to its turnover. The scheme is ideal for small businesses, allowing them to account for VAT using minimal record-keeping requirements and often at quite an advantageous VAT rate.
Mr and Mrs Morgan, trading as the Harrow Inn, had accounted for VAT on sales at 5.5 per cent, the rate applicable to public houses. The percentage rate applied to turnover is determined depending on the type of business. The flat rate percentage for pubs is 5.5 per cent, but 12 per cent for catering businesses, including restaurants and takeaways.
In June 2005, a VAT officer discovered that, for the year ending October 2003, the Harrow Inn's sales of food and drink were almost equal. Sales of drink totalled £72,353, while sales of food were at £81,450. The business was duly reclassified as a restaurant, which increased the percentage flat rate applicable to turnover by 6.5 per cent to 12 per cent.
Despite being named the Harrow Inn, and despite the fact that the business was described as a public house in both the lease and the licence, HM Revenue & Customs (HMRC) decided that the business was predominately a restaurant. As such, they assessed additional VAT on the business, substantially increasing the amount due.
Mr and Mrs Morgan appealed to the VAT Tribunal. The tribunal can only allow an appellant's appeal against a flat rate percentage if they consider that HM Revenue & Customs did not have reasonable grounds for making their decision.
VAT Notice 733 sets out the regulations relating to the Flat Rate Scheme. A business must decide which sector most closely describes what the business will be doing in the coming year, with words given their ordinary meanings. If HMRC approve a business joining the scheme, it will not change the business' choice of sector retrospectively, as long as the choice was reasonable and the business has kept a record as to why it was chosen.
If the business falls into more than one sector, the flat rate is that which is appropriate to the main business activity as measured by turnover. HMRC says in the notice: "Choose the sector for which your business gets the greater part of its turnover."
In the case of the Harrow Inn, the tribunal considered that Mr and Mrs Morgan failed to carry out the required reviews to determine that turnover from the sale of food was greater than turnover from the sale of drink. The tribunal concluded that had they performed the review, Mr and Mrs Morgan would have had to account for VAT at the rate of 12 per cent.
The Morgans' accountant contended that a substantial refurbishment to the bar area would 'drastically' increase bar sales, and take them beyond food sales. The choice of pub as their main trading category had, therefore, been a reasonable one.
The tribunal confirmed that it only had jurisdiction to consider whether HMRC had acted unreasonably, which in the tribunal's view, it had not. The appeal was dismissed.
It would have been interesting to apply and contend another test - that the sale of food was entirely reliant upon the sale of drink. In my view, the turnover test was not the main test which should have been applied. This VAT appeal failed due to the appellant not reviewing the turnover from each activity.
Unfortunately, that argument was not put forward, so the supply of food having the higher turnover determined that the business came under the higher 12 per cent restaurant category percentage.
Clearly many public houses will see an increase in their sales of food due to changes in drinking habits and the ban on smoking in bars and restaurants. A constant review of the business and VAT implications is therefore vital.
