VAT is complicated, and the technicalities and jargon used by some accountants can make even the most seasoned contractors confused. Our easy to read guide has all the information you need to explain what VAT is, how and why to register along with details about what forms to complete.
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.
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 registrations 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.
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.
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- Understanding legislation – what is IR35 and what could it mean for your business?
- Maximising your expenses – find out what business costs you can expense through your company.
- Making your business a success – a look at how to manage your time, market yourself and make your business a success.
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 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 are the benefits of being VAT registered?
- Being VAT registered means that you can reclaim the tax you have been charged when buying goods for your company. There are some goods and expenses which do not incur VAT – for example, insurance, finance, credit, education, training and fundraising events – but on the majority of other goods and services, 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.
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.
You charge VAT on your invoices at 20% but only pay back HMRC at a lower rate. This rate differs depending on your profession or trade and a table of business types and rates can be found in our Flat Rate VAT Scheme guide. These change every time VAT rates change so be sure to check – and remember that in your first year as a VAT registered company when using the Flat Rate Scheme, you receive an extra 1% discount for the year.
This difference in the rate you charge and the rate you pay provides additional income – for example, based on an IT contractor that pays 13.5% of the gross amount and 14.5% in subsequent years (you receive a 1% discount in your first year) and works for 45 weeks of the year:
- 200 per day contract – £1,710 extra per year
- £350 per day contract – £2,992.50 extra per year
- £600 per day contract – £5,130 extra per year
Companies on the Flat Rate Scheme are unable to claim back any VAT on purchased goods and expenses for their business. You can, however, reclaim VAT on capital asset purchases over £2,000, for example, a PC, providing all the capital purchases are on the same receipt – for example a PC, printer and scanner. You cannot, however, buy a PC one month for £1,500 then a printer the next month for £300 and a scanner the month after for £200 and add them together, they must all be on the same receipt.
The Flat Rate scheme still requires you to complete a quarterly VAT return form. You will need to charge the standard VAT rate on your invoices, but when you complete the form you calculate your VAT payable as 13.5% (using the example above) of the amount you have invoiced that quarter – including the VAT. So, for example, if you have invoiced £10,000 VAT in a quarter, you must calculate your payment as 13.5% of £12,000, not 13.5% of £10,000.
Even with having to calculate your VAT payment on your invoice amount plus VAT, the percentage you pay is still considerably lower than that of the standard VAT rate, so in effect, you make a profit. However, you do then have to declare this profit as income and you will be taxed on it accordingly. The Government offers this option as the Flat Rate Scheme is simple for them to manage and you are in effect helping their tax collection process.
Flat Rate Scheme advantages
- You generate extra profit by paying less VAT than you charge.
- There is a reduced amount of paperwork for you to handle.
- You will benefit from an extra 1% reduction in your first VAT registered year.
Flat Rate Scheme disadvantages
- If you buy lots of stock or other items for your business then you cannot claim the VAT back on these.
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. So even though an invoice was sent in March, if the payment was not received until June, then you would not include this piece of business in your end March tax return, but instead wait until your end June tax return.
Cash Accounting Scheme advantages
- 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.
Cash Accounting Scheme disadvantages
- 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.
Make sure to discuss all your VAT scheme options with your accountant before deciding.
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