Okay, so VAT is boring. And it's complicated. But, it's a fact of life for businesses, and in some cases, it can prove to be quite useful. So it's well worth understanding it and how it might benefit your small business.
What is VAT? Well, it's short for Value Added Tax for a start. VAT is a sales tax charged by all VAT registered companies on the value of products or services they supply. There are three rates of VAT:
- Standard Rate 20% - Most goods and services
- Reduced Rate 5% - Domestic fuel, child car seats
- Zero Rate - Books, children's clothes
Some goods and services are VAT exempt — items such as training, fundraising for charities, postage stamps and postage for example.
Zero-rated supplies are not charged VAT in the usual sense but at a rate of 0%. This means you can claim the VAT back on your overheads and costs.
For a definitive list of items that are subject to VAT and their rates, call HMRC (and be prepared to wait a long time!) or speak to your accountant.
If you're registered for VAT, it's essential you understand what records you need to keep, how to compile and submit a return, and how often you need to pay. Filing your return or making your payment late, or making mistakes on your return can be costly. Details of the potential surcharges and fines can be found here ( link).
When do you have to register for VAT?
There are a couple of scenarios where you have to register for VAT:
- You expect your VAT taxable turnover to be more than £85,000 in the next 30-day period. You must register for VAT immediately.
- Your business had a VAT taxable turnover of more than £85,000 over the last 12 months. Remember, this is any consecutive 12 month period, not just your usual accounting period. If you've exceeded the VAT threshold, you must have registered for VAT by the end of the following month.
However, if your business only sells VAT exempt items, you don't need to register for VAT.
You can typically complete your VAT registration online; this is probably the best way as you'll need an online account to be able to submit your VAT returns. If you cannot register online, or you want to apply for an exception (maybe exceeding the VAT threshold was a one-off and it's not going to happen again in the next 12 months) you can contact HMRC by post using form VAT1.
Once you're registered for VAT, you must print your VAT number on all your sales invoices and complete your VAT returns. A VAT return is typically submitted, and payments made every quarter.
VAT Schemes for Small Business
Three schemes can help small businesses ease the burden of dealing with VAT.
- Flat rate - If your VAT taxable turnover is less than £150k per year, you can pay a percentage of your total turnover. It's typically somewhere between 9% and 14% and is dependent on your industry. With the Flat Rate scheme, you still charge 20% VAT to your customers, but you can't reclaim the VAT portion of any purchases you make (except for certain capital purchases over £2,000). The difference between what you can charge and what you have to pay makes up for not being able to claim the majority of VAT back.
- Cash Accounting - The benefit of the Cash Accounting scheme is you only include the transaction on your VAT return after your client has paid you. The alternative Invoice Accounting scheme requires you to include any VAT on any invoices you have sent, regardless of whether you have been paid or not. If your payment terms are 30, 60 or even 90 days, this could mean you have a rather large VAT payment to make based on the income you're yet to receive. As cash flow is key to the success of small businesses, being able to make payments only when you've got the money is a significant plus. The Cash Accounting scheme is only available to companies whose turnover is expected to be less than £1.35 Million per year.
- Annual Accounting - The Annual Accounting system allows you to make either nine monthly or three quarterly VAT payments based on your previous years' VAT return (or an estimate if you're newly registered). At the end of the year, you complete a VAT return and either make a payment for the remaining sum owed or get a refund if you've overpaid. This scheme is useful in that you know what your regular payments will be, allowing you to keep that all-important cash flow under control. It also reduces the paperwork burden as you only need to complete a single VAT return. But, you need to keep careful track of your invoices, so you're not left with a nasty (expensive) surprise when you complete your return. This scheme is only available if your annual turnover is expected to be less than £1.35 Million.
What records do you need to keep?
It's essential that you retain all the records of your business transactions. Documents such as bank statements, bills, receipts, records of all supplies and a summary of your VAT for each tax period covered by your tax returns. HMRC take VAT fraud (or any tax evasion really) very seriously. So having the evidence to support the figures on your returns is essential should there ever be a query or audit from HMRC.
Your records must be kept for at least six years, so make sure you have a sound, secure storage system. In the past, record keeping has been one of the most complained about aspects of the VAT system as it's such an onerous task. In an attempt to make the whole VAT process easier, HMRC has introduced Making Tax Digital (MTD).
Making Tax Digital
The UK Government's Making Tax Digital scheme is designed to reduce the burden of the VAT return. By using approved accounting software, you can maintain your records and submit your VAT return digitally. You need to be compliant with Making Tax Digital now, so if you're not, or you have any questions about it, contact your accountant straight away.
Pros of registering for VAT
There are several benefits to a small business registering for VAT. To being with you can claim back the VAT on any equipment you purchase when setting your business up. Getting started can be an expensive time, so being able to claim some of that money back will help that all-important cash flow.
If you expect most of your trade to be with big businesses, they typically expect you to be able to provide them with a VAT number. It's something that's expected in the business-to-business environment, and it makes you look more professional.
Being VAT registered also has the added benefit of masking the turnover level of your business. If you're not VAT registered, then you're telling the world your business turnover is less than the VAT threshold. Some business, rightly or wrongly, feel more comfortable dealing with more significant partners.
Cons of registering for VAT
I've already mentioned the biggest downside of being registered for VAT, keeping all the records associated with your business activities. This problem is closely followed by completing and submitting your returns on such a regular basis.
Another downside is you have to charge more to non-VAT registered customers, potentially making you a more expensive option compared to your competitors who are not VAT registered.
I no longer want to be VAT registered, can I deregister?
If your annual turnover drops below the VAT threshold, you might consider deregistering for VAT. Before you do this, consider these points:
- Do you generally get repayments from HMRC when you file your tax returns?
- Is your drop in taxable sales going to be temporary?
- Are most of your customers' VAT registered?
If you've answered yes to any of these questions, it might make sense to keep your VAT registration.
Before you do anything regarding your VAT registration, please consult your accountant as they can give you the best advice and prevent you from making a costly mistake.