What is VAT, how does it work and who pays it? When is VAT registration compulsory and what are the advantages and disadvantages of voluntary registration? How much VAT should you charge and how do you complete your VAT returns and payments? All businesses need to understand VAT – even if you do not charge it at present it is important to be aware of the right VAT schemes for particular businesses. This article outlines the basics of VAT and also what small businesses can do to make VAT simpler.
What is VAT and how does it work?
Value Added Tax or VAT is a tax that applies to most business transactions involving the transfer or goods or services. Once your business turnover reaches a certain level (see below) you legally have to pay VAT to HM Revenue & Customs. A business pays VAT on its purchases (known as input tax) and charges VAT on its sales (output tax). If a VAT registered business receives more output tax from sales than it pays on input tax, it has to pay the difference to HM Revenue and Customs. If more input tax has been paid out (on, for example equipment, goods and supplies) than the company has charged VAT for on its sales, the Revenue refunds the difference.
When does registration for VAT become compulsory?
You must register your business for VAT if you supplied taxable goods and services amounting to more than £85,000 in the last 12 month period or if you anticipate supplying taxable goods and services amounting to more than £85,000 in the next 30 day period alone. The government sets the figures and they normally change annually when a new budget is announced.
There are certain types of goods and services that are exempt from VAT, for example insurance, loans, and some education and training. If your business supplies only goods and services that are exempt, then you do not have to register, fill in VAT returns or make payments. However, you cannot claim the VAT back on your purchases.
Why would I want to register for VAT voluntarily?
Despite the hassle of keeping VAT records and the small mountain of paperwork that goes with the territory, there may be advantages to registering voluntarily when a business has a turnover below £85,000. Obviously it means you can reclaim the VAT you pay out on goods and services, which can be considerable depending on your business. It can also increase your credibility as a business, as some companies prefer dealing with suppliers with a VAT number. Having a VAT number can generate confidence, implying stability and the impression that the business may be larger than it is. In addition, if you supply goods to other VAT registered businesses then they can also reclaim the VAT charged.
Of course, on the downside you have to fill in regular VAT returns with details of your sales and purchases, and the accompanying paperwork soon mounts up. Furthermore if your supplies are to the public or non-VAT registered businesses then they cannot reclaim the VAT charged, so your prices might be less competitive than someone not charging VAT. It really depends on what type of business you have.
What changes would I need to make when I register for VAT?
You will need to keep a detailed record of the amount of VAT you charge (i.e. your output tax).
When you make purchases you must remember to get a VAT invoice so you can reclaim any VAT paid. Keep records of the amount of VAT paid for each purchase along with your original records.
What rates of VAT should I charge?
There are three rates of VAT and it is important to know which rate to charge. The standard rate is 20%, there are also reduced rates of 5% and a zero rate for certain goods and services. Even if you only supply goods that are zero rated – for example books, newspapers, young children’s clothing and shoes or food (although not food sold in cafes, bars etc.) you still have to tell HMRC first and apply to be ’exempt from registration’.
It is important to understand the difference between the zero rate and being exempt for VAT purposes. Both mean that you do not charge VAT on the supplies of the relevant goods or services, but the extent to which you can reclaim input tax is fundamentally different. If you make zero rated sales you can recover all VAT that you incur in making these supplies, but if your sale is exempt, you are not able to recover related input tax.
If you make a mixture of taxable (including zero rate) sales and exempt sales you will be partially exempt and need to apportion how much input VAT you reclaim.
When do I complete VAT returns and make payments?
People dread their VAT returns, but there is lots of help and guidance from the tax office and online. Businesses usually account for VAT on a quarterly basis. When you register you will be assigned a tax period and will automatically receive a VAT return to coincide with the end of this period.
The VAT return details how much is payable and how you have calculated it. Your completed VAT return and payment of whatever tax is due is usually one month after the end of your tax period. There are penalties for rendering returns and paying the VAT late. The penalties become more severe as the number of defaults rise.
You can of course submit the return online and arrange for an electronic payment.
How can I make VAT easier for my business?
There are a number of simplified arrangements to make VAT accounting easier for small businesses. If your taxable turnover is under £1.35m a year you can arrange to account to HMRC for VAT on the basis of cash received and paid, rather than the invoice date or time of supply. This “cash accounting” helps cash flow and is particularly useful if you have a lot of late payers. Consider “annual accounting” where instead of completing quarterly VAT returns, a small business with taxable turnover under £1.35m can send in returns once a year. If you are a retailer there are schemes which offer you an alternative if it’s impractical to issue invoices for a large number of supplies direct to the public. There is also “bad debt” relief which you may be able to claim if you do not get paid.
And finally, if your turnover is under £150,000 you can use the flat rate scheme. This scheme saves on administration because you do not have to account internally for VAT on each individual “in and out”. You simply pay over a set percentage of your total turnover. The rate depends on your business type. This scheme is however not suitable for all businesses and you should seek appropriate professional advice before implementing it.
VAT is a fact of life for most businesses and has to be dealt with on a regular, systematic basis. It may not be exciting or stimulating, but it still has to be sorted. Like most other business practices, once a straightforward system is in place and adhered to life becomes easier. Do not let the paperwork mount up or be lax about your VAT obligations. If you really can’t face it yourself then a book-keeper can take most of the pain away, but you still need to be on top of the system.
