When allocating standalone credit notes to invoices with different VAT rates you receive the message:

'There is a mismatch between the net/VAT element of the allocated items which may result in inaccuracies on your VAT return. Do you want to save this allocation?'

The system actively transfers VAT from invoices into a holding account. Upon receiving a payment, it promptly moves this to VAT accounts for tax reporting. If the system issues a credit note without a corresponding payment, it actively nullifies the VAT. Due to varying VAT rates, a residual value may persist in the holding account.

Example

Let’s say you send out an invoice for £100 and add a standard VAT of £20. When the customer pays up, you can see the receipt on your VAT Return. But if the customer sends back the items because they’re faulty, you give them a credit note. This leaves you with a leftover balance of £20 in the VAT on the sales holding account.

The customer then places another order for £120 with a mix of different VAT rates:

• £90 at the standard rate
• £10 at the lower rate
• £1.50, which is VAT exempt
• Total VAT £18.50

Let’s say you send out an invoice for £100 and add a standard VAT of £20. When the customer pays up, you can see the receipt on your VAT Return. But if the customer sends back the items because they’re faulty, you give them a credit note. This leaves you with a leftover balance of £20 in the VAT on the sales holding account.

To rectify this, you can:

• Click ‘No’. Issue a refund for the credit note and mark the invoice as paid. Include the refund and payment on the VAT Return to account for the difference. The bank balance remains unchanged as the refund and receipt cancel each other out.
• Unallocate the receipt and invoice, then apply the credit note to the original invoice.

To correct the VAT discrepancy, journal the amount from the VAT holding to the VAT on the sales account.

The following journal entry illustrates this: