By James Poyser of inniAccounts
If you’re a business owner, especially one just starting out, then understanding VAT can seem a little overwhelming. But it needn’t be and this article will help to demystify VAT, and explain why it’s often best practice to register your company for VAT.
So let’s start at the beginning:
What is VAT?
VAT stands for Value Added Tax – an amount of tax added to the value of goods and services you purchase. VAT exists to raise revenue for the government and all VAT-registered businesses must charge VAT on the goods or services they provide. A service can range from hairdressing, the sale of office furniture, or the service you provide as a self-employed actuary.
The standard VAT rate currently stands at 20%, which means that if you are VAT registered and you charge a customer £1,000, you need to add on an additional £200 for VAT and charge £1,200 in total. The £200 is then given to HMRC.
On the other hand, if your business is charged VAT, and you are VAT registered, then you can reclaim it. For example, if you’ve purchased £250 of goods and have been charged £50 VAT, you can deduct this from the amount payable to HMRC on your sales.
Does VAT apply to all goods and services?
No. Some services are ‘exempt’ such as education and training, and some are ‘zero rated’ such as books and newspapers. Fuel and power used by charities qualifies for a ‘reduced’ rate of 5%. It’s worth checking with your accountant how this will affect your business, and, if you are selling only exempt goods, you do not need to be registered for VAT. If you trade outside of the UK they can also advise you on country-specific VAT requirements.
So will VAT impact me?
As a business owner, you’ll need to be aware of VAT. If your company’s sales - the ‘VAT taxable turnover’ - exceeds £82,000 per year then you must register for VAT. You can, however, register voluntarily below this threshold.
Why would I voluntarily register?
A good question. Think of it like this, if the clients you provide goods and services to are mainly VAT-registered businesses then you will not be disadvantaged by charging VAT. They won’t see the VAT as an administrative burden as they will already be in the habit of claiming back the VAT companies charge.
So with this in mind, there are three reasons why you may wish to voluntarily register:
Being VAT registered attracts a certain amount of credibility. Other businesses may perceive you to be professional, well-established and committed to business. It also masks the fact that your turnover is less than £82,000, which may be helpful if you want to give the impression of stature.
2. To access the flat rate VAT scheme, a way to make a small profit as a services company
If your business has a low level of outgoings, you may stand to benefit financially from becoming VAT registered, and in particular the flat rate VAT scheme – we’ll run through that in the next section.
3. Contractors who find work through an agency
If you’re self-employed and find work through an agency, even if you’re earning less than £82,000 per year, then you should consider registering for VAT. You will not be disadvantaged and as you’re likely to have low outgoings you can take advantage of the flat rate VAT scheme.
So what is the flat rate VAT scheme? The standard 20% VAT scheme requires businesses to keep accurate records on every transaction noting the VAT paid or charged. The VAT Flat Rate Scheme (FRS) was introduced by HMRC to simplify this process of recordkeeping for small businesses.
Flat rate VAT also presents an opportunity for businesses with minimal expenditure to make a small profit. With FRS, instead of tracking VAT on all transactions, you simply pay a fixed flat-rate percentage of your gross turnover to HMRC. The percentage you pay is set by HMRC, and varies according to your industry. For example, IT contractors will pay flat rate VAT at 14.5%. This means you’ll still charge your clients VAT at 20%, but you’ll only pay 14.5% of the invoice amount including VAT to HMRC - the difference is yours to keep and is a payment in lieu of you reclaiming VAT on each individual expense.
The flat rate VAT scheme will benefit most businesses who have a turnover of less than £150,000 in the first year. However if you have a lot of expenses that incur VAT or if you provide goods or services that are zero rated, charged at lower rate or are exempt then the flat rate scheme might not be for you. This is because the difference between what you charge and pay HMRC through the Flat Rate Scheme may not cover the VAT you incur through business expenses.
When should I not voluntarily register?
If you’re providing goods and services to individuals or business who can’t reclaim the VAT, such as private individuals. In this case, by charging VAT you will needlessly increase your prices by 20%, potentially making you less competitive.
Where do I register?
You need to register directly with HMRC www.hmrc.gov.uk/vat. Once you’ve registered you then need to keep meticulous records of all VAT related transactions and keep the evidence for six years.
How do I report and pay VAT?
You’ll need to file a VAT return with HMRC every quarter and pay any VAT due. If you’re using the flat rate VAT scheme you’ll simply calculate and pay a percentage of your turnover. Otherwise you must account for all the VAT you’ve charged, and deduct all of the VAT you’ve paid.
You should now be in a position to determine which path is right for you. If you are still unsure then a good accountant will help you to not only understand the nuances for your business, but also help you organise your VAT administration so you pay an accurate amount on time, and reclaim what you are entitled to.