There are moments in business when discovering something new is exciting.
A new destination. A new tour. A new sales channel. A new booking system.
Discovering the Tour Operators’ Margin Scheme because HMRC has just written to say it would like to inspect your VAT records is not one of those moments.
I recently spoke to the directors of an established UK travel business after an HMRC travel company VAT inspection exposed precisely this problem.
This was not a newly incorporated business which had made a few bookings and had not yet found an accountant. It was a substantial operation with employees, significant turnover, an internal finance function and an external accountancy firm preparing its statutory accounts.
In other words, there were plenty of people involved in “the accounts”.
And yet, when HMRC announced a VAT compliance check, the directors suddenly discovered that there was a rather important question nobody appeared to have dealt with properly:
Should the business have been using TOMS?
The answer, once I understood what they sold, was not particularly mysterious.
The company put together travel packages and sold them in its own name. Some elements were bought from third-party suppliers, while other services were provided from within the business.
This was not an obscure VAT question hiding in a dusty corner of the tax legislation.
This was a travel business with a travel VAT problem.
Unfortunately, nobody had been treating it as one.
When bookkeeping quietly becomes tax policy
One feature of this case particularly illustrates a problem I see repeatedly.
The company had an internal employee looking after the day-to-day finance records. She had evidently become the person responsible for much of the bookkeeping and VAT information supplied to the accountants.
There is nothing inherently wrong with that.
Many of my clients maintain their own bookkeeping internally. In fact, with a sufficiently large business it is perfectly sensible to have somebody in-house dealing with invoices, payments, bank reconciliation and the daily financial administration.
The problem begins when bookkeeping gradually turns into tax decision-making without anybody noticing that the boundary has been crossed.
At some point, the VAT treatment of certain travel costs had changed.
VAT started being recovered on costs where the treatment under the travel VAT rules required considerably more thought.
Nobody had deliberately announced:
“Today our internal bookkeeping employee will become Head of Specialist Travel VAT.”
It simply happened by administrative drift.
A way of recording something changed. A different assumption was made. The VAT returns continued to be prepared and submitted.
And because VAT returns are repetitive, an error can become a system remarkably quickly.
Quarter one looks like quarter two. Quarter two becomes quarter three. Eventually everybody assumes that this must be how it has always been done because there are twelve previous spreadsheets saying so.
A spreadsheet is remarkably good at performing the same wrong calculation with tremendous consistency.
But there was an accountant
This is the obvious question.
The business had external accountants.
So how did nobody stop this?
The answer is that there is a significant difference between general accounting compliance and specialist travel accounting.
An accountant may be perfectly capable of preparing statutory accounts, submitting Corporation Tax returns and dealing with ordinary VAT.
That does not automatically mean that the accountant understands how a tour operator should be structured for VAT purposes.
Travel businesses have an irritating habit of refusing to behave like ordinary businesses. My guide to VAT and TOMS for UK travel agents and tour operators explains the wider framework in more detail.
You cannot simply look at an expense carrying VAT and conclude that VAT is recoverable.
You cannot simply look at sales and apply the VAT treatment you would use for an ordinary consultancy, retailer or service company.
You first have to understand what the business is actually supplying.
Is it acting as principal?
Is it acting as agent?
Is it buying travel services which are incorporated into a package?
Does it provide any elements itself?
Are there different types of transactions running through the same business?
Those questions come before the arithmetic.
That is precisely why I am forever saying that TOMS is not something you bolt onto the bookkeeping at quarter end.
The accounting system has to understand the travel business first.
Then the HMRC letter arrived: When a travel company VAT inspection exposes the problem
Until HMRC wrote, the weaknesses had remained largely invisible to the directors.
Then suddenly the company was told that HMRC wanted to inspect its VAT records.
At that point everybody started ricocheting from one corner to another looking for answers.
What have we actually been doing?
Was it right?
How far back does the problem go?
Have we underpaid VAT?
Have we overpaid VAT?
Was last year wrong?
Were the years before that wrong?
What exactly is HMRC going to find when it looks?
And somewhere during this process came the particularly unpleasant discovery:
“Apparently we should have been using something called TOMS.”
This is not where any established travel business wants to be a few weeks before an HMRC inspection.
The directors’ instinct was perfectly understandable. They wanted somebody to review everything immediately, calculate the correct position and establish whether anything needed to be disclosed or corrected before HMRC arrived.
That is possible.
What is not possible is doing it responsibly by looking at one spreadsheet prepared by the same system which may have produced the problem.
A TOMS review is not a spreadsheet blessing ceremony
When there may be historic VAT errors, I do not want somebody to send me a spreadsheet and ask:
“Does this look right?”
The question is not whether the spreadsheet contains formulas.
The question is whether the underlying accounting treatment is right.
That means going back to the records.
I need to understand how the company sells its tours, what customers are buying, what suppliers provide, which services are bought in, which services are provided internally and how those transactions have been recorded.
The VAT returns need to be reconciled to the accounting records.
The accounting records need to be reconciled to the underlying commercial activity.
Changes in treatment need to be identified.
If a particular category suddenly started being treated differently fifteen months ago, I want to know why.
Who decided?
Was advice obtained?
Did an accountant give an instruction?
Did somebody alter a bookkeeping code?
Was the treatment inherited from an old spreadsheet?
Or did somebody simply look at an invoice containing VAT and assume that VAT must therefore be reclaimable?
That distinction can matter enormously.
It is also why specialist remedial work is completely separate from ordinary monthly accountancy.
You are not simply preparing the next VAT return.
You are reconstructing how the business arrived at the numbers already reported to HMRC.
The other dangerous idea: “Can you just check what our bookkeeper does?”
The directors also wanted ongoing support once the immediate problem had been resolved.
Their initial idea was that the internal finance employee would continue calculating everything, their existing accountants would continue dealing with the accounts and I would sit somewhere behind the arrangement checking the TOMS calculations.
No.
That is exactly the sort of fragmented arrangement which creates these problems.
Accountant A prepares the annual accounts.
Employee B does the bookkeeping.
Specialist C checks one VAT calculation.
Director D assumes somebody somewhere is responsible for making sure the whole thing fits together.
Then HMRC asks a question and everybody looks at everybody else.
Sometimes the warning signs that it is time to change accountants appear long before HMRC exposes the consequences.
My own model is deliberately different.
Where I act for a travel business, I need end-to-end oversight of the accounting function.
That does not mean the client cannot have an internal bookkeeper or finance employee. They absolutely can.
But I need to control the accounting framework within which that bookkeeping operates.
I review it.
I correct it.
I deal with the VAT and TOMS.
I prepare the annual accounts and Corporation Tax return.
If something changes in the business model, I know about it because I am already involved in the accounting architecture.
There is one line of responsibility rather than a committee.
It is considerably less exciting.
That is the point.
Systems matter as well
This company was also using accounting software which did not fit the way I structure travel businesses.
That matters.
Travel accounting needs information which ordinary bookkeeping frequently ignores.
For a tour operator, the economic event which matters for specialist VAT purposes does not necessarily align neatly with the date somebody typed an invoice into the accounting system.
The system therefore has to be designed around the business.Choosing the right accounting software for travel businesses matters, but no software can decide the correct VAT treatment for you.
I use Xero for my travel clients because I can structure the accounting records in a way which gives me the tracking and oversight I need.
That is not a religious conviction concerning accounting software.
Nobody is being baptised into Xero.
It is simply a professional requirement of the service.
If I am responsible for getting the numbers right, I also need to be able to control how those numbers are produced.
The lesson is not “be frightened of HMRC”
HMRC compliance checks happen.
Receiving an inspection letter does not automatically mean HMRC believes a business has committed some terrible offence.
The real lesson from this case is much more mundane.
Do not wait for HMRC to test your accounting system before you test it yourself. A travel company VAT inspection should not be the first serious test of whether your accounting system actually reflects the way your business operates.
If you operate a travel company, somebody involved in your accounting needs to understand travel.
Not merely VAT.
Not merely bookkeeping.
Travel.
That person needs to understand the commercial model before deciding how the accounting and VAT should work.
An internal bookkeeper can be excellent at bookkeeping and still not be the person who should determine specialist VAT treatment.
A general accountant can prepare perfectly respectable statutory accounts and still fail to identify that the underlying travel VAT methodology is wrong.
Neither fact makes anybody incompetent in everything.
It simply means that specialist industries eventually punish generic assumptions.
Travel is one of those industries.
The expensive part is usually discovering the problem late
Had this company’s accounting structure been reviewed properly from the start, the work required would have been comparatively straightforward.
Establish the business model.
Determine the correct treatment.
Build the accounting system appropriately.
Review it regularly.
Done.
Instead, the question arose after multiple VAT periods had already been submitted and shortly before HMRC was due to inspect them.
Now historic records have to be examined.
Previous treatment has to be reconstructed.
The correct position has to be established.
Any error has to be quantified.
HMRC’s correspondence has to be considered.
And the company needs a credible accounting system going forward so that the answer to HMRC is not merely:
“We think we fixed the spreadsheet.”
That is an expensive way to discover the difference between having an accountant and having the right accountant for the business.
If you run a travel company and nobody in your accounting relationship has ever had a serious conversation with you about TOMS, principal versus agent arrangements, bought-in travel services, in-house supplies and how your booking activity connects to your VAT records, I would not wait for HMRC to start that conversation for you.
