VAT is simpler than it is usually made out to be, but you need to approach it step by step and crunch the numbers involved to find your best way to deal with it.
This is because, in addition to the normal way of paying VAT (known as the Standard Rate Scheme), HMRC also offers the Flate Rate Scheme, the Cash Accounting Scheme and the Annual Accounting Scheme for small businesses with turnover under a certain amount.
Each of these change your tax liability and how you pay in different ways. We shall deal with them at the end of the article.
The Standard Rate Scheme is the essence of VAT however, and it neither overly complex nor particularly difficult to get your head around. We cover it next.
What is VAT?
Most of us are familiar with, or have a basic understanding of VAT (Value Added Tax). It is a type of consumption tax added to the cost of most goods and services for both B2C and B2B markets.
VAT is charged on:
- items sold to staff (i.e. staff canteen meals)
- sale of business assets
- business sales (ie goods or services you offer as a business)
The 3 rates of VAT, and the 1 exception
Different goods and services are charged VAT at 1 of 3 different rates. Nearly everything falls within the 20% Standard Rate however.
Those 3 rates are:
Standard rate (currently 20%)
The standard rate applies to most goods and services. This is the rate that you should charge, unless the goods or services are classified as reduced or zero rate.
This applies to goods you supply to non-VAT registered EU customers that fall below the distance selling threshold (if you exceed the threshold, you need to register for VAT for that country).
The standard rate also applies to most services you supply to non-business customers in the EU. For EU business customers, there's a different set of rules that apply.
Reduced rate (currently 5%)
The reduced rate may apply depending on the type of product or service. It is generally charged on sanitary products, children's car seats and energy saving measures.
The reduced rate may also apply based on the context of the sale. For instance, it will apply to mobility devices if it is purchased by an individual over 60, and installed in his or her home. Any accountant should be able to quickly go over your sales and expenses and tell you which categories you do most of your business within.
Zero rate (0%)
Zero-rated goods are still VAT-taxable, but the rate of VAT that you charge to customers is 0%.
You are still required to record these sales in your VAT accounts, and report them on your VAT return.
Some examples of zero-rated items include books, newspapers, children's clothes and shoes and goods you export to non-EU countries.
Exempt or out of scope items
There is also one instance where no VAT is charged, not even at zero rate.
A few examples of exempt items include insurance, medical services provided by doctors and postal service. The full list of exempt items can be viewed on the Gov.uk website. These transactions should however still be recorded in your general business accounts.
Out of scope items are outside the scope of VAT. As such, if you sell or purchase these goods and services, you can't charge VAT or reclaim the VAT on them. These items include employee salaries, charges imposed by the government and donations to a charity.
The first step: am I legally required to pay VAT?
Not all businesses are legally required to pay VAT. If you turnover is below a certain threshold you will have no legal obligation to pay VAT.
You must however register for VAT if:
- your VAT taxable turnover exceeds the current threshold of £85,000 within a 12-month period. The VAT taxable turnover refers to the total value of everything that you sell that isn't exempt from VAT.
- you expect your VAT taxable turnover to exceed £85,000 in the next 30-day period
- your business had a taxable turnover exceeding £85,000 over the last 12 months
You need to register for VAT within 30 days of fulfilling any of these conditions. If you fail to register on time, you'll need to pay what you owe from the date that the registration should have been effective. HMRC may also impose a penalty, depending on the amount you owe, how late your registration is and other situational factors.
Step 2: voluntary VAT registration? Benefits and downsides
In certain circumstances, it can be beneficial to register for VAT - even if you're not required to. We've included the main benefits and downsides you need to consider below:
- It enhances the perception of your business. Registering for VAT tends to lend credibility to your business, and makes your company appear larger and more established. This can enhance your market appeal to other businesses and customers.
- You can reclaim VAT: You can reclaim VAT on goods and services you've purchased from other businesses, and this can be advantageous in certain situations. For example, you may be manufacturing and selling children's clothes (a zero-rated item), yet typically pay the standard VAT rate for most of your purchases - ranging from raw materials to manufacturing costs. If your input tax is higher than your output tax, you will be eligible for VAT refunds.
- Administrative burden. As a VAT-registered business, there are VAT rules and record keeping requirements you'll need to comply with. Some of these rules can be complicated, and you may be liable to a penalty if you make a mistake.
- It makes your goods or services seem more expensive. Charging VAT can make your goods and services more expensive - and therefore less appealing, particularly if your customers or clients are not VAT-registered business, or are end consumers who aren't able to reclaim VAT.
- You may be faced with an unexpected VAT bill. If your output VAT is higher than the input VAT, as it nearly always will be, then you need to pay the difference to HMRC. This can create cash flow issues if you're unprepared for an unexpected VAT bill. Bear in mind that at 20% these can get to be quite large.
How to register for VAT
You can register for VAT online through creating a VAT online account (also known as the 'Government Gateway' account). You'll need your online account to submit your VAT returns.
What do I need to do after I've registered for VAT?
Once you've registered for VAT, you'll need to:
- Abide by HMRC's record keeping requirements
- Issue VAT invoices
- Submit your VAT returns on time
1. Abide by HMRC's record keeping requirements
VAT-registered businesses are required to keep records of:
- copies of invoices issued
- all invoices received
- self-billing agreements
- name, address and VAT number of self-billing suppliers
- debit or credit notes
- import and export records
- records of items you can't reclaim VAT on
- records of goods you give away or take from stock for private use
- records of all the zero-rated, reduced or VAT exempt items you buy or sell
- a separate record of the VAT you charge and the VAT you pay on your purchases. This is known as the VAT account.
- general business records, such as bank statements and receipts
- your business name, address and VAT registration number
- any VAT accounting schemes you use
- the 'time of supply' and 'value of supply' (value excluding VAT) for everything that you purchase and sell
- the VAT on everything you purchase and sell
You need to keep records for a minimum of six years. If you're using the VAT MOSS service, you need to keep records for 10 years.
2. Issue VAT invoices
Depending on the type of VAT invoice you are issuing, you need to include the following:
*If items are charged at different VAT rates, you'll need to indicate the rates for each item.
3. Submit your VAT return
You will need to submit your VAT return online every quarter, even if you don't have VAT to pay or reclaim. How often you need to submit your VAT return may vary depending on the VAT scheme you choose, and we'll dive into this in further detail in the next section.
The deadline for submitting a VAT return and making payments is a month and seven days after the end of a VAT period. Here's an example: for a VAT period ending 31 March 2019, the due date for submission will be 7 May 2019. If you fail to submit your VAT return on time, you'll incur a penalty from HMRC.
As the first stage of Making Tax Digital has been launched in April 2019, you'll now need to use MTD functional compatible software to file your VAT return.
VAT accounting schemes
In addition to the standard rate scheme, small businesses are also eligible for other VAT schemes. These are intended to minimise the administrative burden and cash flow issues faced by small businesses.
Standard rate scheme
Under the standard rate scheme, you'll reclaim VAT on each item your buy or sell, paying HMRC 20% from your invoices.
Flat rate scheme
The flat rate scheme is available for small businesses, and was introduced to simplify the VAT process.
Rather than pay out the difference between the VAT you've charged to your clients and the VAT on your purchases, you'll pay HMRC a fixed rate of VAT.
To be eligible for the scheme, you need to have an annual turnover of £150,000 or less (excluding VAT). We've covered the flat rate scheme and limited cost trader in further detail in a separate article.
Cash accounting scheme
Under the cash accounting scheme, you account for VAT on the date that you're paid - rather than the date that you send out an invoice. This is particularly helpful for small businesses dealing with late payers or cash flow concerns, as you'll pay VAT only after you've received payment.
To be eligible for the cash accounting scheme, your estimated turnover for the following tax year shouldn't exceed £1.35m. Once you're on the scheme, you can use it until your turnover reaches £1.6m.
Annual accounting scheme
With the annual accounting scheme, you'll make VAT payments on account. You can make either nine monthly payments or three quarterly payments (along with a balancing payment), and are required to complete one annual VAT return.
As with the cash accounting scheme, your estimated turnover for the following tax year shouldn't exceed £1.35m. And once you're on the scheme, you can use it until your turnover reaches £1.6m.
Your turnover, cash flow pattern and the type of clients or customers you have are just some of the factors you need to assess when it comes to choosing a VAT scheme.
Picking out the right option for your business will bring about considerable time and cost savings, so it is a decision that requires careful consideration. It's best to consult a qualified accountant before you register for a scheme. And if you have further questions, feel free to get in touch via our contact form.
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