VAT adjustments in Xero allow a business to correct or supplement the figures generated from its recorded transactions before submitting a VAT Return. Adjustments may be needed for previous-period errors, bad debt relief, partial exemption, fuel scale charges, pre-registration VAT or information brought across from earlier accounting software.
An adjustment should have a clear purpose and supporting calculation. It should not be used simply to force the VAT Return or VAT control account to match an expected figure without identifying the underlying reason for the difference.
The appropriate method depends on whether the original accounting transaction is wrong, whether the adjustment affects the wider accounts and whether the relevant VAT Return has already been submitted to HMRC.
What VAT adjustments in Xero are used for
VAT adjustments in Xero can change the amount reported in a specific VAT Return box without altering every underlying transaction individually.
Xero also allows an adjustment to create an accounting transaction. This records the change in both the VAT Return and the relevant ledger accounts through a manual journal.
Examples of circumstances that may require an adjustment include pre-registration VAT on a first return, late claims, partial-exemption calculations, annual adjustments and corrections carried forward from previous software.
Xero’s official VAT Return adjustment guidance explains how a box-only adjustment differs from one that also creates an accounting transaction.
Correct the original transaction where possible
Where an invoice, bill, credit note or bank transaction has simply been entered with the wrong VAT code, correcting the underlying transaction is often the clearest approach.
The amended transaction then updates the VAT reports and preserves a direct connection between the supporting document and the VAT treatment.
This may be appropriate where the wrong rate was selected, a purchase was incorrectly marked as having no VAT or a reverse-charge code should have been used.
Before editing a transaction, check whether it falls within a VAT period that has already been filed. Changes to a filed period can appear as late claims or corrections in a later VAT Return and should be reviewed carefully.
When a VAT box adjustment may be appropriate
A direct VAT box adjustment may be appropriate where the change does not arise from one ordinary sales or purchase transaction.
Examples can include an externally calculated partial-exemption adjustment, a fuel scale charge or figures covering the portion of a VAT period completed in previous software.
A box adjustment can also be used on the first Xero VAT Return to bring in qualifying pre-registration VAT or other amounts that are not already represented by Xero transactions.
The adjustment reason should explain what the figure represents and refer to the supporting schedule retained by the business.
Box-only adjustments compared with accounting adjustments
A box-only adjustment changes the VAT Return but does not automatically change the balance-sheet or profit and loss accounts.
This can leave a difference between the submitted return and the VAT control account if no corresponding accounting entry exists elsewhere.
Where the adjustment should also affect the financial records, Xero allows the user to select an option that creates an accounting transaction.
The account and VAT rate used for that transaction must be selected carefully. An incorrect account can fix the VAT Return while creating a new error in the accounts.
Keep a clear adjustment audit trail
Every VAT adjustment should be supported by a record showing the amount, VAT Return box, accounting period and reason for the change.
Where a calculation was completed outside Xero, the schedule should be retained with the VAT working papers.
Making Tax Digital rules permit certain VAT adjustment calculations to be completed outside the compatible software. The total for each type of adjustment must still be recorded digitally within the VAT account.
HMRC’s Making Tax Digital for VAT notice explains the digital-record requirements applying to adjustments.
Review the VAT Return before adding adjustments
Before entering an adjustment, complete the ordinary bookkeeping for the VAT period.
Record all known sales, purchases, credit notes, imports, refunds and other relevant transactions. Reconcile the bank accounts, credit cards and payment platforms.
Review VAT coding and investigate unusual transactions before deciding that the remaining difference requires a manual adjustment.
An adjustment should not compensate for incomplete transaction processing or an unreconciled bank account.
Reconciling the VAT control account
The VAT control account should reflect output VAT on sales, recoverable input VAT, adjustments, submitted returns and payments to or from HMRC.
After a VAT Return is submitted, the related liability or repayment should agree with the amount shown in the accounting records.
Payments to HMRC should be matched against the VAT liability rather than posted as new tax expenses. Refunds should reduce the amount receivable from HMRC.
An unexplained balance carried forward for several periods may indicate missing payments, duplicated journals or historical adjustments that were not reflected correctly in the ledger.
Use the VAT reconciliation reports in Xero
Xero’s VAT reports show the transactions included in each VAT box and the VAT treatment applied.
The Transactions by VAT Box and Transactions by Tax Rate views can be used to investigate the figures and identify adjustments.
Review large, unusual and negative entries individually. Compare the total sales and purchases with other business reports where appropriate.
The VAT account should also be compared with filed returns and HMRC payments rather than relying solely on the figure displayed on the submission screen.
VAT adjustments for previous-period errors
A business may discover that a VAT Return already submitted to HMRC contained an error.
Non-deliberate net errors from the preceding four years can generally be corrected on the next VAT Return where the net value is £10,000 or less.
An error between £10,000 and £50,000 can also normally be corrected through the next return where it is less than 1 per cent of the total value of sales entered in Box 6 for that return.
Errors exceeding these limits, and all deliberate errors, must be reported separately to HMRC.
HMRC’s VAT error-correction guidance explains the current thresholds and reporting process.
Calculating the net value of errors
The threshold test is applied to the net VAT effect of the errors being corrected.
Add together errors that resulted in too little VAT being paid to HMRC, then subtract errors that resulted in too much VAT being paid.
Deliberate errors must not be included in this net calculation because they require separate disclosure regardless of value.
The business should retain a schedule showing each error, when it was discovered, how it arose and the resulting VAT correction.
Correcting errors through the next VAT Return
Where the error meets HMRC’s conditions for correction through the next return, the net amount is generally added to Box 1 where additional VAT is due to HMRC.
Where the correction results in VAT being reclaimed, the amount is generally added to Box 4.
The correction must also be entered in the VAT account and supported by adequate records.
The accounting entries in Xero should reflect the nature of the error rather than recording an unexplained adjustment with no corresponding analysis.
Late claims in Xero
A late claim can arise where an eligible purchase from an earlier period was not included in the VAT Return originally submitted.
When a transaction dated within a filed period is added or corrected later, Xero may include the resulting VAT as a late claim in the next open return.
The late-claims section should be reviewed before filing to confirm that each item is valid, supported and within the permitted correction period.
A large late claim or one involving uncertain VAT treatment should not be submitted automatically without further investigation.
Bad debt relief
A business using invoice accounting may have paid output VAT to HMRC on a sales invoice that the customer has not paid.
VAT bad debt relief may be available where the statutory conditions are met. The business must already have accounted for and paid the VAT and must write the debt off in its VAT records.
The debt must generally remain unpaid for six months after the later of the payment due date and the date of supply.
The business must also maintain a separate bad debt relief account containing the required details of the debt and claim.
HMRC’s VAT bad debt relief notice sets out the full conditions.
Recording bad debt relief in Xero
The accounting treatment should first reflect that the customer debt has been written off appropriately.
The VAT relief must then be included in the relevant return with a clear audit trail and supporting schedule.
The treatment can depend on the Xero workflow, VAT scheme and how the original invoice was recorded. The adjustment should not create a second write-off or duplicate the VAT recovery.
If the customer later pays some or all of the debt, the related VAT may need to be repaid to HMRC.
Credit notes and VAT adjustments
A supplier or customer credit note should normally be entered as a credit note and allocated against the relevant bill or invoice.
This allows the accounting and VAT records to reflect the reduced value of the original transaction.
Using a manual VAT adjustment instead of entering a genuine credit note can leave customer or supplier balances overstated.
Where the original transaction was included in a filed VAT period, the later credit note should be reviewed to ensure it appears in the correct subsequent return.
Partial-exemption adjustments
A business making both taxable and exempt supplies may be unable to recover all of its input VAT.
Input VAT directly attributable to exempt activity is generally restricted, while residual VAT may require an apportionment calculation.
The partial-exemption calculation can produce an adjustment for each VAT period and a further annual adjustment.
The supporting calculation may be maintained outside Xero, but the appropriate adjustment total should be recorded within the digital VAT records.
Partial exemption can be complex, so businesses should obtain specialist VAT advice where the correct method is uncertain.
Fuel scale charge adjustments
A VAT fuel scale charge may apply where a business reclaims VAT on road fuel that is also used privately.
The charge is based on the vehicle’s carbon dioxide band rather than the actual amount of private mileage.
The relevant output VAT and net value may need to be included through an adjustment or suitable accounting transaction.
The business should retain information identifying the vehicle, applicable scale charge and VAT period.
Pre-registration VAT adjustments
A newly registered business may be able to reclaim qualifying VAT on goods acquired up to four years before registration and services supplied within the previous six months.
The conditions differ for goods and services, and valid VAT invoices must normally be held.
Where qualifying pre-registration purchases are not already included as ordinary Xero transactions within the first return, a supported VAT adjustment may be required.
The claim should be supported by a schedule showing the supplier, invoice date, amount, VAT and reason the cost qualifies.
Conversion adjustments when moving to Xero
A business moving to Xero partway through a VAT period may already have part of that period recorded in previous software.
The first Xero VAT Return may therefore require an adjustment for the earlier portion of the period so the complete return is submitted.
The figures should agree with reports from the previous system and should not duplicate transactions imported into Xero.
The conversion date, opening VAT balance and submitted-return history should be reviewed together before the first Xero filing.
Reverse-charge transactions
Reverse-charge VAT is normally recorded by applying the appropriate Xero tax rate to the underlying sales or purchase transaction.
This allows the relevant output and input VAT figures to flow into the correct VAT Return boxes.
A manual adjustment should not be used merely because the transaction initially had the wrong VAT code. Correcting the original transaction will often provide a clearer record.
Construction domestic reverse-charge transactions, overseas services and other reverse-charge arrangements can affect several VAT boxes, so the coding should be checked carefully.
Postponed import VAT accounting
Businesses using postponed VAT accounting should compare the import VAT recorded in Xero with the monthly postponed import VAT statement obtained through the Government Gateway.
Estimates may sometimes be needed where a statement is unavailable at the filing date, but these should be corrected when the final information becomes available.
Import VAT should not be reclaimed solely from a freight invoice or bank payment where the required customs evidence is missing.
Differences between estimated and confirmed amounts should be documented and included in the appropriate later return.
Capital Goods Scheme adjustments
The Capital Goods Scheme can require annual VAT adjustments for certain high-value land, buildings, computers, aircraft and vessels.
The adjustment reflects changes in the proportion of taxable and exempt use over the applicable adjustment period.
The calculation is normally maintained through a separate schedule and the resulting VAT entered into the relevant return.
This is a specialist area and should be reviewed with an appropriately qualified VAT adviser.
Making Tax Digital and VAT adjustments
Making Tax Digital requires specified VAT records to be maintained digitally within compatible software.
HMRC allows only the total for each type of VAT adjustment to be recorded in the compatible software. The detailed calculation can be maintained separately.
Where the adjustment changes input tax or output tax relating to a supply, the original digital transaction does not necessarily need to be amended.
The VAT Return must nevertheless be generated and submitted from the functional compatible software, with each adjustment included in the digital VAT account.
Submitting the MTD VAT Return from Xero
After transactions and adjustments have been reviewed, the return can be submitted to HMRC through Xero’s Making Tax Digital connection.
The user should confirm the VAT period, review late claims, check the VAT Return boxes and obtain approval before filing.
The submission status should be checked to confirm HMRC accepted the return. A draft or attempted submission is not the same as an accepted filing.
Our VAT returns service can include transaction review, reconciliation, adjustments and MTD submission within an agreed bookkeeping engagement.
Do not amend a filed VAT Return directly
A VAT Return already submitted to HMRC is not ordinarily reopened and replaced within Xero.
Corrections are normally reflected through the next return or reported separately to HMRC according to the error-correction rules.
Editing transactions from a filed period can affect late claims and future reports, so the consequences should be reviewed before changes are made.
The filed return, supporting reports and adjustment schedules should remain available as part of the audit trail.
Common VAT adjustment mistakes
A common mistake is using a box adjustment to conceal incomplete bookkeeping or an unreconciled VAT account.
Another is entering a box-only adjustment when the wider accounting records also need to change.
Businesses may also correct the original transaction and add a separate adjustment for the same amount, creating a duplicate correction.
Other errors include posting corrections to the wrong VAT box, failing to retain calculations and treating a deliberate error as an ordinary next-return adjustment.
Review adjustments at year end
All VAT adjustments entered during the accounting year should be reviewed as part of the year-end process.
The VAT control account should agree with filed returns, HMRC payments and the closing amount payable or recoverable.
Old adjustment accounts and unexplained journal balances should be investigated before the records are sent to the accountant.
Our guide to Xero year-end explains the wider reconciliation and accounts-preparation work required at the end of the financial period.
Getting help with VAT adjustments in Xero
The first step is to review the underlying transactions, filed-return history, VAT control account and supporting records.
We can then identify whether the correct approach is to amend a transaction, enter a VAT Return adjustment or report the error separately to HMRC.
Bookkeeping Packages Ltd provides Xero bookkeeping services that can include VAT coding, reconciliation and MTD Return preparation.
To discuss VAT adjustments in Xero and the condition of your VAT records, use the Bookkeeping Packages enquiry form or call 0161 531 0087.
About the Author
Stuart Kerr is Managing Director of Bookkeeping Packages Ltd, an outsourced bookkeeping service supporting UK small businesses and accountancy practices. With over 20 years of bookkeeping experience, Stuart specialises in helping businesses maintain reliable financial records and useful management information.
This article is provided for general information only. Stuart Kerr is a professional bookkeeper, not a tax, legal or regulated financial adviser. Nothing in this article constitutes tax, legal or financial advice or representation during an HMRC enquiry. VAT adjustments and error corrections can depend on the circumstances, and advice specific to your position should be obtained from an appropriately qualified professional.