How to account for VAT on deposits
I’ve been asked by a client how they should account for VAT on deposits they take.
When a deposit is received for a future supply of goods or services, you have to account for VAT at the appropriate rate, i.e. 0%, 5% or 15%. It might be your standard practice to take a deposit to cover the cost of obtaining materials needed to carry out the work, or where your customer has not been granted credit facilities.
For example: if you quote a fee for work to be carried out of, say, £2,000 plus VAT, and requests a deposit of 25%, here’s how you would account for VAT?
First, the simple approach: ask for the deposit in a letter or using a pro-forma invoice. Neither require any VAT to be accounted for until the deposit is received, at which time you raise a VAT invoice so that your customer can recover the input VAT.
Second, you raise an invoice, and account for VAT on it in the normal way.
What if your customer doesn’t pay?
You claim back the VAT from the VAT office on your VAT return under Bad Debt Relief rules. Unfortunately this means you don’t get the VAT back until the debt is six months old, counting from the date payment is due. If you are offering 30 days credit on your invoice you will have to wait seven months from the date of issue to claim bad debt relief.
Using Cash Accounting would bring with it automatic bad debt relief.
Invoices
How do you invoice for the deposit, and subsequent supply? This is relatively straightforward, but causes some confusion as some may expect it to be complicated. The deposit invoice would have the following information on it, in addition to the usual invoice information:
| Deposit for XYZ project | 500.00 |
| VAT | 75.00 |
| Total | 575.00 |
The final invoice would then have this information shown on it:
| Fee for XYZ project | 2,000.00 |
| Less deposit | 500.00 |
| Balance due | 1,500.00 |
| VAT | 225.00 |
| Total due | 1,725.00 |
The total VAT accounted for in this way is £300, which is 15% of £2000.
Beware! When considering asking for deposits remember to mention that VAT will be added to them. If VAT isn’t added to the deposit, the above example would look like this:
| Deposit for XYZ project | 434.78 |
| VAT | 65.22 |
| Total | 500.00 |
The final invoice would then have this information shown on it:
| Fee for XYZ project | 2,000.00 |
| Less deposit | 434.78 |
| Balance due | 1,565.22 |
| VAT | 234.78 |
| Total due | 1,800.00 |
This still results in you receiving a total of £2,000, and accounting for VAT of £300, but the deposit received was nearly 22%, rather than 25% wanted.
If you operate cash accounting you avoid the bad debt relief problem. More information on the cash accounting scheme will be posted soon.
If you have been, thank you for reading.
Any questions? Comments? Please leave them below. Thank you.
Related posts:
Hi
Just to clarify, When a deposit payment is recieved under the imple approach mentioned above i.e after issuing a pro forma do you HAVE to issue a vat invoice? Can you not wait until the service takes place? and just account for the deposit vat on the vat return each period?
tks
Hi Phil
Sorry for the delay in responding.
The standard rule is that you need to issue the VAT invoice for the deposit within 30 days of receiving the payment. Unless your customer is a VAT registered business you may only need to provide a receipt – but that’s still paperwork, so why not issue a VAT invoice? The important thing is that you account for the VAT out of the deposit in the right VAT period.
For hotels where the reservation is cancelled any cancellation fee that is retained is not subject to VAT, so any VAT that has already been paid can be reclaimed – even if the whole of the deposit is retained.
Does that make it clearer?
Robert