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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 Flat 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.
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:
- business sales (i.e. goods or services you offer as a business)
- sale of business assets
- items sold to staff (i.e. staff canteen meals)
Ultimate VAT Guide
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.
It 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.
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
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.
When do I need to register for VAT? The £85,000 UK VAT threshold
Not all businesses are legally required to pay VAT.
If your 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 (for the 2021/22 tax year). 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.
One question we get asked a lot is:
If my business turnover goes over £85,000 - do I need to pay VAT on all this previous revenue?
No. You will need to start paying VAT for the period from the date that you register or from when you reached the £85,000 threshold. You'll need to ensure you're tracking this and can be done easily with accounting software like FreeAgent. We also include this for free with any of our accounting packages.
What are the Advantages vs. Disadvantages of VAT registration?
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:
VAT Registration Advantages:
- 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.
VAT Registration Disadvantages:
- 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.
Ultimate VAT Guide
- What is VAT
- When to register for VAT
- VAT rates
- Exempt/ Out of Scope VAT items
- VAT filing responsibilities
- De-registering for VAT
- What is VAT
- When to register for VAT
- VAT rates
- Exempt/ Out of Scope VAT items
- VAT filing responsibilities
- De-registering for VAT
When do I pay VAT?
After you've registered for VAT (more below) then you'll need to file your VAT return and pay VAT 1 month and 7 days after the end of your VAT quarter.
This is the most common VAT scheme for smaller businesses with some that have an annual filing scheme (this is reserved for larger companies but can still mean monthly and quarterly filing). This is covered below but isn't a common requirement for the large majority of businesses in the UK.
With quarterly VAT filing, this means that you'll need to make sure you're on top of your accounting admin at the end of each VAT quarter end to ensure you file and pay the right amount of VAT.
You'll find that you'll fall into one of three groups for your VAT quarter end and filing period:
VAT Quarter Ends: Group 1
- January: covers period 1st November to 31st January. You need to file your VAT return and pay by March 7th.
- April: covers period 1st February 30th April. You need to file your VAT return and pay by June 7th.
- July: covers period 1st May to 31st July. You need to file your VAT return and pay by September 7th.
- October: covers period 1st August to 31st October. You need to file your VAT return and pay by December 7th.
VAT Quarter: Group 2
- February: covers period 1st December to 28th February. You need to file your VAT return and pay by April 7th.
- May: covers period 1st March to 30th May. You need to file your VAT return and pay by July 7th.
- August: covers period 1st June to 31st August. You need to file your VAT return and pay by October 7th.
- November: covers period 1st September to 30th November. You need to file your VAT return and pay by January 7th.
VAT Quarter: Group 3
- March: covers period 1st January to 31st March. You need to file your VAT return and pay by May 7th.
- June: covers period 1st April to 30th June. You need to file your VAT return and pay by August 7th.
- September: covers period 1st July to 30th September. You need to file your VAT return and pay by November 7th.
- December: covers period 1st October to 31st December. You need to file your VAT return and pay by February 7th.
How to register and what do I need to do after registering for VAT
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.
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
Starting 1 April 2021, UK businesses with a turnover exceeding the VAT registration threshold are required to follow the Making Tax Digital (MTD) rules. Businesses with a turnover below the threshold have the option of signing up for MTD voluntarily. From April 2022, it is mandatory for all VAT-registered businesses to comply with MTD, regardless of their annual turnover.
Under MTD, you're required to keep and maintain VAT records in “a compatible software package that allows you to keep digital records and submit VAT Returns” or use “bridging software to connect non-compatible software (such as spreadsheets) to HMRC systems”. And if more than one software package is used, the packages need to be linked digitally.
Records you need to keep digitally:
- Business name, address and VAT registration number
- Any VAT accounting schemes you use
- The VAT on goods and services you supply, for example everything you sell, lease, transfer or hire out (supplies made)
- The VAT on goods and services you receive, for example everything you buy, lease, rent or hire (supplies received)
- Adjustments you make to a return
- The ‘time of supply’ and ‘value of supply’ (value excluding VAT) for everything you buy and sell
- The rate of VAT charged on goods and services you supply
- Reverse charge transactions
- Total daily gross takings (if you use a retail scheme)
- Items you can reclaim VAT on if you use the Flat Rate Scheme
- Total sales and the VAT on those sales (if you trade in gold and use the Gold Accounting Scheme)
You're also required to keep digital copies of documents that cover multiple transactions made on behalf of your business by:
- Volunteers for charity fundraising
- Third-party businesses
- Employees for petty cash expenses
- HMRC's resource on VAT record keeping
- HMRC's Notice on digital record keeping (4.1), functional compatible software (4.2) and digital links (4.2.1)
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.
Under MTD, the deadlines for submitting your VAT returns remain the same. You're required to submit a VAT return, and make payments a month and seven days after the end of a VAT period.
Here's an example: for a VAT period ending 31 March 2021, the due date for submission will be 7 May 2021. If you fail to submit your VAT return on time, you'll incur a penalty from HMRC.
What are my options if I can’t pay VAT?
Running into cash flow issues is a common problem for small businesses. If you find yourself faced with the situation where you’re unable to pay VAT, these are steps you can take:
- Submit your VAT return: Don’t put this off, even if you can’t pay.
- Contact HMRC about setting up a Time to Pay (TTP) Arrangement: You might be able to set up a Time to Pay arrangement with HMRC, which allows you to pay your tax bill through a series of monthly instalments. Generally, TTP arrangements will not last beyond 12 months. In most instances, you’re expected to pay in full within three months.
- How to contact HMRC: The method you should use to contact HMRC will depend on whether you’ve received a payment demand, such as a tax bill or letter informing you about legal action that will be taken. If you’ve received a payment demand, you need to call up the HMRC office that sent out the letter. If you haven’t received a payment demand, you should call the Payment Support Service.
- Work out your options: Speak to your accountant to draw up a plan on how you can meet your payments on time. You may look into small business financing options such as a line of credit or invoice factoring to help bridge your cash flow gap.
Deferred VAT payments due to coronavirus
If you deferred VAT payments between 20 March and 30 June 2020 and still have payments to make, you have the following options:
- Pay the deferred VAT in full on or before 31 March 2021
- Join the new VAT deferral payment scheme, which is open from 23 February 2021, up until 21 June 2021. Under the new payment scheme, you have the option of paying the deferred VAT (due between 20 March and 30 June 2020) through a series of smaller, interest-free instalments. Instead of making the payment in full by 31 March 2021, you’ll have until the end of March 2022 to complete your payment. Refer to the Gov.uk guide for further information.
- Get in touch with HMRC if you’re still unable to pay the VAT due, and need further assistance
Cancelling my VAT registration
You may cancel your VAT registration online or by post.
You’ll need your Government Gateway user ID and password to cancel online.
Cancel by post
You’ll have to fill in the VAT7 form in full, before printing it out and posting it to HMRC. The address for mailing is included in the form.
It’s best to have all the information you need to fill in the form on hand, as you won’t be able to save a half-completed form.
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 you 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).
For further information, refer to our article on the flat rate scheme and limited cost trader.
Cash vs Invoice 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.
The invoice scheme will mean that you pay VAT for the period when the invoice is generated, not when payment (cash) is received.
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.
The cash based scheme is definitely the best scheme for new businesses.
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.