VAT
The concept of VAT and registering for VAT are familiar to most people. However, less well known is that VAT comprises a third of all government revenue. Even though VAT is one of the most important taxes, it remains one of the least understood.
What is Value Added Tax or VAT and how does it work?
VAT is a value tax that is added to an item or service when it is bought or sold which is then collected by HMRC. Goods or services are either exempt from having VAT added or a value tax of a certain percentage rate will be added.
To understand how VAT works we need to know about the two types of VAT:
INPUT tax, which is added to purchases and can be claimed back from purchases if you are VAT registered.
and
OUTPUT tax, which is the VAT you add onto your sale price and then have to give to HMRC as your VAT bill.
Registration for VAT
There are 3 types of VAT registration
- Compulsory Registration: you must register any business that has made taxable supplies (sales) of more that £85,000 in any 12 month period or less, or if at any point you realise your taxable supplies (sales) will go over the £85,000 in the next 30 days. In this case you have 30 days from the day you realise to get your VAT application into HMRC. The day you realise is day 1, it is important not to miss this registration period.
- Voluntary registration: This is when as a business you choose to become VAT registered even though your taxable supplies are less than the compulsory registration figure. Generally, businesses choose voluntary registration after advice from a qualified accountant.
- Intending Trader registration: A business may register for VAT before making any taxable supplies, but it will have to prove to HMRC that it intends to make taxable supplies.
Implications of VAT registration
Disadvantages of registration include having to add VAT onto your prices, which might make your price less competitive.
Likewise, a big drawback from VAT registration is the extra filing charges your business is likely to incur. Generally, VAT returns, or at least business VAT return systems, are filed or put in place by an accountant. Late filing penalties or incorrect filing charges can be heavy.
Once you are VAT registered, all your receipts have to contain certain information https://www.gov.uk/vat-record-keeping/vat-invoices
The main benefit of VAT registration is you can reclaim the VAT on your business purchases.
Additionally, if your goods and services are mainly purchased by other VAT registered businesses they will be able to claim back the VAT on purchases made from you.
For those thinking of registering:
If we assume both sales and purchases are standard rated (20%). For most businesses purchases cost less than the revenue from sales (unless you are just starting out) otherwise you won’t be making any profit and the viability of the business will be in question. If the above is true that purchases cost less than sales then you will always end up owing VAT to HMRC because your output tax is greater than your input tax.
If your input tax is higher than your output tax and you are reclaiming VAT on a regular basis you are likely to come under the scrutiny of HMRC at some point, whether they indicate this to you or not, as they will want to make sure you are following the VAT rules correctly as you’re reclaiming more than you pay in VAT.
Voluntary VAT registration – why would you?
When, as a business, you sell items / products that are zero rate or reduced rate of VAT and your purchases are standard rate VAT.
For example, if you make children’s clothes, these are sold at a zero rate of VAT but the fabric and thread you use to make the clothes is at a standard rate VAT (20% added to the price). If you are registered at this point, you would be able to claim back the VAT on your purchases (Input VAT) but there would be no VAT to add onto your sales (Output VAT) as your sale item is zero rated. Therefore, HMRC would give you back VAT from your purchases effectively decreasing your costs without increasing your prices.
Therefore, voluntary VAT registration may be advantageous, if your Input tax is greater than your output tax and the costs incurred with the extra filing don’t out way the reclaimed amount.
Intending to trade
If you are intending to trade and want to claim back the input tax on your pre trade expenditure, for example, start-up costs, you may wish to register as intending to trade. However, you will have to prove to HMRC that you are about to trade taxable supplies. You will need evidence such as a business plan, evidence of ongoing advertising or a business loan; these are all examples of possible proof.
Categories of VAT
Goods and Services have 5 categories for VAT
- Outside the scope of UK VAT *
- Exempt (this is not the same as zero-rate)
- Zero Rate – 0%
- Standard Rate – 20%
- Reduced Rate – 5%
Taxable supplies
For VAT to be liable the transaction must happen in the UK by a taxable corporation or person.
A taxable supply is anything that is not exempt or outside the scope of VAT.
Outside the scope
Some goods and services are categorised as outside the UK VAT system, so you cannot charge or reclaim VAT on them. For example, goods or services bought and used outside the UK.
https://www.gov.uk/vat-businesses/when-not-to-charge-vat
Exempt Supplies
For example, training and education, including fitness is exempt therefore if you were a tutor or a personal trainer then at no point would you register for VAT, even if your turnover were to go over the £85k as all your services are exempt.
https://www.gov.uk/vat-businesses/when-not-to-charge-vat
If you are making a mixture of exempt and non-exempt supplies make sure you have a competent accountant, because partial exemption rules need to be followed and for most people this will require a professional. The penalties for incorrect VAT returns can be as high as the VAT owed plus a fine of that amount again. In some cases, if HMRC take the view that the incorrect filing constitutes evasion, then the fine is unlimited and a prison sentence can be of up to 7 years.
Zero Rate
When your taxable supplies / sales at a zero VAT rate, you are able to reclaim input tax when registered for VAT. Items in the zero rate include most food items, children’s clothes, books (including eBooks) and newspapers. For a full list see https://www.gov.uk/guidance/rates-of-vat-on-different-goods-and-services
Standard Rate
If a goods / service is not exempt, zero rate or reduced rate (5%) then it has to be 20% – standard rate.
At a standard rate full input tax (on your purchases) can be reclaimed once VAT registered.
Reduced rate VAT – 5%
If your services / goods are rated at 5%, this includes domestic items such as insulation, boilers, solar panels or domestic fuel supply then you would be able to reclaim your input tax, once registered. For a full list of 5% rate VAT see https://www.gov.uk/guidance/rates-of-vat-on-different-goods-and-services
Exporting
Most goods or services that are exempt from VAT are not physical items, therefore if you are exporting the chances are the goods you export will be rated at one of the 4 other categories of VAT. In this case you will probably want to check with a professional as to whether you come under the ‘Outside the scope of UK VAT’ bracket or whether your service is at a specific percentage rate.
Hopefully this article has improved your understanding of VAT. If you are thinking of becoming VAT registered Duport would always advise on talking to a qualified accountant about your individual business requirements.
