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Retainers and VAT
Hi,
We’ve been using Harvest for a couple of months now, (and on the whole it’s fantastic and has saved us many hours compared to our old methods.)
I’m trying to figure out how retainers with VAT (sales tax) work with businesses in the UK where a limited company will pay or reclaim the VAT on the invoice depending on whether they issue or receive the invoice.
This is best explained with a simple example.
I send the client an invoice for a retainer for £1000. This has 20% VAT on it and so the invoice will read.
Subtotal: £1000
Tax (VAT): £200
Amount Due: £1200
All great so far, we pay £200 VAT and the client then reclaims the £200 VAT from HMRC (the UK IRS) and everything is great.
However, if the next month I do £2000 worth of work with that client, we arrive at an invoice that states the following.
Subtotal: £2000
Tax (VAT): £400
Retainer Payments: £1200
Amount Due: £1200
Now the VAT now states £400, which is incorrect! The Tax/VAT is £200 as we have already paid HMRC £200 for the £1000 on the retainer.
If issued like this, the customer will reclaim £600 on £2000 (and we will pay £600 on £2000!)
The only way forward I can see is to make the invoice in Harvest a “Pro-forma” and writing “THIS IS NOT A VAT INVOICE” all over it, taking the money off the client and not charging VAT.
(I think the main thing that is throwing me here is in the past we have charged for time in advance rather than keeping a credit including VAT)
How do other people make retainers work in regards to tax – especially UK VAT?
Hi Dan! Being that retainers are not a payment for a good or service — they’re simply a way of pre-paying for future work to be done — do you need to collect VAT on them?
Not directly, but Harvest automatically puts in the VAT column. Also if I put VAT at 0, it then does not give the client any idea of the VAT that will be claimed on it.
To put it another way. I either put
Service X £1200
or
Service X £1000
VAT £200
The second invoice is more accurate, but the customer then might accidently put it through as a VAT invoice and reclaim VAT on the service not being provided. Which isn’t a problem until they then reclaim it again on the invoices that are paid from that retainer.
I’ve spoken to my accountant a lot on this matter. At the moment I have been advised to put “PROFORMA – THIS IS NOT A VAT INVOICE” in the PO and Subject fields to ensure it is very clear that it is not a VAT invoice and that a double VAT claim by my clients does not occur.
Rereading your message.
“Yes, we do need to collect the VAT on them.” is the answer. The original retainer needs to have the VAT collected so when a retainer is paid off in the future, the VAT is paid as well.
Well, I’m certainly not familiar with the way VAT is collected, so I’ll defer to any other UK users on the forum! Or, better yet, can you or your accountant come up with an ideal Retainer Invoice that would meet your needs, so we know how we can improve Harvest in the future?
I would also add to this topic as I was looking for a way to see company cash flow after VAT. The problem here is that for expenses the number in Harvest equals the number we have to pay but for revenues we have to deduct VAT to see how much money we actually have made.
The way VAT works in Estonia (I guess UK is similar) that companies must pay VAT for the sums they have charged for in a month but they can deduct the VAT from incoming invoices during that period. If company earns €100 they invoice €120 (20% VAT) and if they buy goods and services for the same amount during that month they have no obligation to pay VAT. Also, If company earns less than it spends (happens when you buy some equipment etc) they can ask for VAT refund.
Back to Harvest. Let’s say I have currently three projects, budgeted for €1000 each, with VAT I will invoice €3600. One project has some print production for €600 (incl VAT). How much money company made? Correct is 2500 but in Harvest I would see 3000.
When we charge foreign companies we do not charge VAT, that makes the overview even more complicated. Same goes to the retainer example Dan was making: the VAT is paid based on invoices, not on transactions: if the payment period is half a year, the VAT is paid when the invoice is issued, not when the money gets paid.
Easy fix? Keep track on cash and VAT separately. If Dan has worked for £2000 and has invoiced previously for £1200 then you have to make Harvest to note that £200 of that previous sum was charged as VAT and now the client will be charged £1200 again, the system treated this £2000 as “sum to be invoiced” and paid invoice of £1200 as “sum already received”.
This is quite common with sales tax in general, I think, when both paying it and collecting it. However, keeping track of tax credits is probably best done inside your accounting software or by your bookkeeper. Harvest was designed primarily as a time tracking and billing tool, not really to handle accounting.
That said, if you generate an invoice report from Harvest under Invoices > Reports, the total at the bottom of the report will break out the total tax charged to clients.
I hope that helps!