VAT is complicated. The technicalities and jargon used by some accountants can make even the longest-standing contractors slightly confused, so we’ve aimed to create a jargon-free, back to basics guide to value-added tax.
Firstly, what is VAT?
VAT – or Value Added Tax – is a consumption tax which is applied to nearly all goods and services in the UK and the EU. If your business is VAT registered, you need to charge VAT on sales and can reclaim VAT made on purchases from other registered businesses.
To make things a little more complicated, there are certain things that are zero-rated like food, books, newspapers and magazines, young children’s clothing and footwear but I wouldn’t worry about these for now.
When and why should I register for VAT?
Registration for VAT is compulsory when the annual turnover of your business reaches a set amount – this is currently set at £85,000. It is important that you keep a close eye on your turnover if you think it might be going to hit the threshold, as you have to register as soon as this happens. A common mistake is either to wait until the end of a calendar quarter or worse, to wait until your annual income tax return.
You should also register if you expect that your turnover will exceed the threshold in the next 30 days – this period can start at any time. This rule could affect you if a large contract is under discussion with a customer and, under this rule, registration is required immediately so that the large contract in question will be subject to VAT.
All the required VAT registration forms are available on HMRC’s website, but one thing to remember is that the VAT threshold amount can change, so make sure to check each year.
However, even if your turnover doesn’t meet the threshold for the year, you can still register for VAT voluntarily at any point.
What happens if I don’t register for VAT?
If you fail to register for VAT at the appropriate time, you may be liable for a penalty. This is calculated at 5%, 10% or 15%, depending on the delay between the date of hitting the threshold and the date which HMRC received registration notification. Up to 9 months delay incurs a penalty of 5% then up to 18 months is 10% and over 18 months is 15%. You should keep a copy of your registration notification as postal delays could affect the date on which HMRC receives it – as a penalty can be mitigated or cancelled in total if there are genuine circumstances which prevented you from submitting your application on time.
Can I register for VAT even if my turnover is below the threshold?
Yes, you can register for VAT at any point, and as many as 20% of all VAT registered businesses choose to do so. Registering and having a VAT number may help give your company the appearance of being larger than it is, and also when quoting for work, some companies insist that suppliers must be VAT registered. Many small businesses also do this so that they can claim the VAT back on items purchased.
It is worth remembering though that being VAT registered may make you more expensive than your non-VAT registered competitors. For example, if you aren’t VAT registered currently and you sell a product for £100, then this is all your customers will pay. If you then become VAT registered, you’ll have to charge VAT on top, or soak up the difference yourself and reduce your profit margin. Before registering for VAT in this situation, it’s probably best to have a chat with an accountant.
If you want to register for VAT, despite not reaching the threshold, you will need to satisfy HMRC that you are carrying on a business, or intending to carry on a business and that you are making what is known as ‘taxable supplies’. Satisfactory evidence will need to be provided and a covering letter is also helpful, to pre-empt any questions that HMRC might ask. The last thing to remember is that you do not have to be a limited company to register for VAT.
When do I start charging for VAT?
You will start charging on the day you register for VAT, not the day you receive your certificate – as it can take up to 30 days for this to arrive.
Whilst waiting for your VAT certificate, you will need to raise your invoices as a total figure, which includes the sale amount and the VAT amount. Then, once you have received confirmation of your VAT number, you can add this to your invoices, separate the sale and VAT amounts, and re-issue to your customers – who will then be able to reclaim the VAT which you have charged.
How to register for VAT
The easiest way to register for VAT is online through HMRC’s portal, though you can register using a VAT1 form.
When you register, you will be prompted to create a VAT account (sometimes known as a Government Gateway account). You will need this to submit your VAT returns to HMRC. An accountant can do this for you, or you can register yourself.
If you register for VAT yourself, you will need the following information:
- Your National Insurance number
- Your company’s certificate of incorporation
- Details of all associated business within the last 2 years
- Details of your business bank account
- Records of sale if you’ve bought the business
Once you register, you will receive the following:
- Your VAT number
- Your date of registration
- When to submit your first VAT return
You will receive a certificate within 30 days of registration.
What are the benefits of being VAT registered?
Here are some of the benefits of being VAT registered:
- Being VAT registered means you can reclaim the input tax you have been charged when buying goods for your company. There are some goods and expenses which you will incur where you have not been charged VAT.
- There is no VAT on insurance, finance, credit, education, training and fundraising events, the majority of other goods you will be charged VAT. Being VAT registered adds more credibility to your business, making it appear larger than it is, as well as creating a more professional image.
- Some companies only deal with VAT registered suppliers, so this will give you more opportunities to deal with more suppliers.
- Customers and clients that are VAT registered can reclaim the VAT you charge them. Again it creates a more professional image and the customer may then be more inclined to use you again in the near future knowing you are both VAT registered and that they can possibly reclaim their input tax also.
What is a VAT return?
If you are VAT registered, you must submit a return to HMRC quarterly to show how much VAT you are due to pay.
The return must show all the total VAT your company has charged your customers on products and services which you have provided (your output tax). It must also include the VAT you wish to claim back against charges you have incurred on purchases for your company – for example, supplies, equipment, stock and so on. This is known as input tax.
The key thing to remember is that the VAT return must include all income invoices during that quarter, not income received – even if you do not get paid for 30 days or more afterwards. Once the VAT form is submitted, HMRC will then review it, and should your outputs exceed your inputs, you must then pay the difference to the Government. However, if your inputs exceed the outputs, your company is then entitled to a refund.
What is the Flat Rate VAT Scheme?
The Flat Rate VAT Scheme is an incentive provided by the government to help simplify VAT for small businesses, especially those who provide a service and therefore do not have large amounts of VAT to reclaim for business purchases. It is, therefore, the chosen scheme for most contractors and freelancers.
Learn more about this by reading our guide to the Flat Rate VAT Scheme.
Standard VAT Accounting
Being registered on the standard scheme means you can reclaim VAT on purchases that you have been charged VAT on. Using the standard accounting method means that every quarter you would be required to fill in a standard VAT return form (online only).
This must include:
- All output tax – this is the VAT which you have charged to customers/clients on your invoices in the relevant quarter. Whether you have or have not received payment for the goods/services provided, you still must add this to your VAT return form in that quarter.
- All input tax – this is the VAT which you have been charged by suppliers on goods or expenses your business has incurred during the relevant quarter. Again – whether or not you have paid for the goods or expenses – you must add this to your VAT return form in that quarter.
Using this method means that you would ask to reclaim VAT based on the date of your raised invoice rather than the date the invoice is paid for. For example – if you were completing a VAT return form for the first quarter ending March:
|Date invoice raised||Date invoice paid||Date to file and pay your VAT||11th March||12th June||March (first quarter)|
You must include the invoice in the quarter the invoice was raised, not the month the payment was received.
- You do not have to register for VAT until you reach the £85,000 threshold within a rolling 12 month period of your business starting – however, once this amount is reached it is mandatory to be VAT registered
- Some companies voluntarily register for VAT – this could be for many different reasons; customers will only do business with VAT registered companies or you may be looking to purchase many goods where VAT is chargeable and can be reclaimed
- Standard VAT is currently 20%
Advantages of using Standard VAT Accounting
Even if you have not paid for goods purchased, you can still reclaim the VAT from HMRC in the quarterly VAT return, great for your cash flow.
Disadvantages of using Standard VAT Accounting
You have to pay VAT over to HMRC for service or goods sold which you may have not yet received the money for, not great for cash flow, especially for new businesses.
Annual VAT Accounting
The Annual VAT Accounting Scheme is largely the same as the standard scheme except it allows contractors to submit one annual VAT statement rather than four throughout the year. The contractor will pay in instalments and pay a settlement figure at the end of the year. A company can join if its annual turnover is £1.35 million or less.
Advantages of using Annual VAT Accounting
Some limited company directors find Annual VAT Accounting easy as it allows you to budget and spread payments across the year.
Disadvantages of using Annual VAT Accounting
If you claim back tax regularly, it may not be beneficial as you can only claim VAT back once a year.
There is the potential for inaccurate payments as the VAT figure is based on amounts paid in the previous financial year.
What is the Cash Accounting Scheme?
The Cash Accounting Scheme is best suited for businesses who do not wish to pay VAT until their customers or clients have paid for their goods or services – but it cannot be used if your annual turnover is more than £1.35 million.
Each quarter you will be asked to fill in your VAT return form for HMRC stating your output tax and input tax in a very similar way to the standard VAT return. However, you cannot claim or reclaim VAT on purchases or services that have not yet been paid for.
Here is an example if you were completing a VAT return form for the first quarter ending March:
|Date invoice raised||Date invoice paid||Date to file and pay your VAT|
|11th March||12th June||June (Second quarter)|
Even though the invoice was supplied in March, and technically is in the first quarter cut off, the payment was not received until June, meaning you would not claim back VAT on this invoice until the second quarter. The payment must be received before adding this to your quarterly VAT form.
Advantages of using the Cash Accounting Scheme
The Cash Accounting Scheme benefits the cash flow of the business as you will only be required to pay VAT to HMRC once you have received payment from your customers.
Disadvantages of using the Cash Accounting Scheme
You will not be able to reclaim VAT on any goods purchased until you have actually paid for them. If you decide to leave the Cash Accounting Scheme, any outstanding VAT will need to be paid to HMRC before you leave the scheme.
Contact SJD Accountancy
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VAT is one of the most complex and onerous tax regimes imposed on business and many businesses inadvertently overpay or underpay VAT.
The ever-widening scope of VAT, the constant stream of detailed changes to the regulations, and the ever-growing demands of Customs and Excise call for a trained professional eye to ensure that you do not fall foul of the regulations and do not pay the Exchequer more than you need to.
We provide an efficient cost-effective VAT service, which includes:
- Assistance with VAT registration
- Advice on VAT planning and administration
- Use of the most appropriate scheme
- VAT control and reconciliation
- Help with completing VAT returns
- Planning to minimise future problems with Customs and Excise
- Negotiating with Customs and Excise in disputes and representing you at VAT tribunals
- Making Tax Digital compliant software
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