Although in first view VAT looks simple as if applied it is generally at one standard rate of 20% which has remained static for some considerable time now, the reality is that VAT is one of the most complex of UK taxes. As well as the standard rate there is a reduced rate of 5%, a zero rate as well as exempt items or things which are outside of the scope of VAT.
Potentially businesses have to register for VAT and complete returns in other EU countries that they operate in when they reach certain thresholds.
The actual calculation of the tax due is generally easy. However there are many rules, regulations and schemes meaning that getting the right advice, at the right time, from a suitably qualified VAT professional, is essential for many businesses. For now though let’s take a look at the key facts that small-business owners should know about VAT.
The reality of VAT
VAT is a tax on the sales that you make, subject to certain rules. VAT on sales is known as output tax. It is only charged by VAT registered businesses who collect VAT on behalf of HMRC and pay it over to them, usually, once a quarter. VAT registered businesses can offset against the VAT due to HMRC the amount of VAT that they have paid on goods and services that they have purchased. VAT incurred on goods and services is known as input tax.
It is the net of the output tax less input tax that is paid to HMRC. If the input tax exceeds the output tax then a refund from HMRC will be due.
This is better explained by an illustration:
If a business sells £1,000 of services in a quarter excluding VAT then the gross, VAT inclusive, sales would be £1,200 (£1,000 plus VAT at 20%). The output tax would be £200.
If the business incurred costs in the same quarter of £360 which had VAT on them of £60 (the input tax) then the amount of VAT paid over to HMRC would be £140 (£200 output tax less £60 input VAT).
If your business is not registered for VAT then you do not charge it and you cannot claim back any VAT that you may have paid on items you’ve purchased. Basically you just forget about VAT all together. You do not separate it out in any accounting records nor must you add it onto your invoices.
In reality being VAT registered means that your prices increase by 20% but you are no better off for it! If you are selling to VAT registered businesses then VAT usually has no impact as your VAT registered customers can claim the VAT back on their purchases (as input tax), unless that business cannot claim VAT back (as is the case in e.g. financial services and education). However consumers (the general public) and businesses who are not VAT registered cannot claim VAT back. So adding VAT can make your prices less competitive when selling to those who aren’t VAT-registered. It’s certainly something to consider when setting or agreeing a price and it’s essential to make sure that customers are aware that VAT will be added on your invoice.
Many have tried, and failed, to get around these price issues by coming up with schemes to avoid the need to register for VAT. For example by artificially separating out turnover to bring the businesses below the VAT registration threshold e.g. by operating two or more businesses. This is illegal and any attempt to avoid VAT registration when the conditions are met should be avoided.
When to register for VAT
A business must register and account for VAT if their VAT taxable turnover (the total value of everything sold that is not exempt from VAT) in the previous 12 months exceeds the VAT threshold. This rule applies to all businesses including sole traders and not just limited companies. Note should be taken that the rules apply to a rolling 12 month period and not to the financial or accounting year of the business.
Caution – A common mistake made when considering whether to register for VAT is to assume that “turnover” relates to the current accounting year, rather than the 12 months leading up to the current date. For example, if a business has a year end of 31 March and turnover for that accounting year is £82,000 it doesn’t have to register for VAT as at 31st March. However as it moves into the next accounting year if the turnover from 1st June to 31st May is £90,000 over that 12 month period then the business will need to register for VAT.
You must also register for VAT if you:
• expect your turnover to go over the threshold in the next 30 days
• take over a VAT-registered business as a going concern
• sell goods into the UK from another EU country and exceed the “distance selling threshold”
• buy goods from other EU countries totalling more than the VAT threshold in a year.
Voluntary VAT Registration
If your turnover is less than the VAT registration threshold you can still register for VAT, known as voluntary registration. Voluntary registration is beneficial when the value of your input tax (VAT on purchases) exceeds your output tax (VAT on sales). This would be the case if the things that you sell do not have the full rate of VAT on them e.g. zero rated or exempt supplies such as certain, but not all, food items or qualifying educational services. It is vital to check the rate of VAT that you should charge on your sales – see https://www.gov.uk/guidance/rates-of-vat-on-different-goods-and-services for more information. If you only sell goods or services that are exempt from VAT you do not have to register.
What is the VAT Threshold?
The VAT registration threshold is £90,000. It has been at this level for a number of years although, like any tax thresholds, it could change in the future.
VAT registration number
When a business registers for VAT it is allocated a VAT registration number. In England, Scotland, and Wales, a VAT registration number consists of the letters ‘GB’ followed by nine numbers. You can check the validity of a VAT number and find the address that it is registered to at https://www.gov.uk/check-uk-vat-number.
What are the rates of VAT?
The VAT rate businesses charge depends on the goods and services being supplied. The rates of VAT that need to be applied are:
| VAT rate % | Rate | Description |
| Standard rate | 20% | Most goods and services |
| Reduced rate | 5% | Some goods and services, e.g. children’s car seats and home energy |
| Zero rate | 0% | Zero-rated goods and services, e.g. most food and children’s clothes |
Some things are exempt from VAT, such as postage stamps, financial and property transactions. It is important to apply the right rate of VAT to your transactions. This will usually be 20%.
If you are supplying goods or services to customers outside of the UK then different rules will apply. If this is something that you do then you will need to become familiar with:
If in doubt then seek advice from a suitably qualified expert or accountant.
How to register for VAT
The best way to register for VAT is on the GOV.uk web site.
You will need a Government Gateway log on to do this. If you do not have one of these you can get one when you apply for VAT registration. Once VAT registration has been applied for a VAT online account will be created. This will allow you to view your VAT account as well as set up a Direct Debit to pay VAT, view VAT payments, check any penalties applied, report changes to your business and cancel your VAT registration should you wish to do so.
Your VAT quarter end dates
After you register HMRC will issue a VAT registration certificate showing your VAT registration number and will tell you your VAT quarter end dates. Don’t assume that these will be 31st March, 30th June, 30th September and 31st December. It is worth noting that your first VAT return may cover more than a quarter.
You can choose your VAT quarter ends when you register giving you the option of aligning these with your year end date or you can change the quarter end dates later via your government gateway account (select “Your Business Details” and the option to change the dates) or by completing a form VAT484. Accounting for your VAT will be simpler with the quarters aligned to your accounting year although, if you are using software, there isn’t a necessity to do this as the system will work things out for you.
What to do after you’ve registered for VAT
After registration, you should tell your customers that you’re now VAT registered. VAT will need to be added to the price of things they buy from you. You need to show the VAT amount on any invoices or receipts that you give to your customers and show this in your accounts separately from your turnover.
You also need to record in your accounting system the VAT that you have paid on any purchases so that you can offset this on your VAT return.
What to show on a VAT invoice
A VAT invoice must generally show:
• a unique invoice number that follows on from the previous invoice
• your name or trading name and address
• your VAT registration number
• the invoice date
• the tax point (i.e. the time when a sale is treated by HMRC as having taken place) if this is different from the invoice date
• the customer’s name or trading name and address
• a description of the goods or services supplied.
For each type of item you sell you must show the:
• unit price or rate – excluding VAT
• quantity of goods or the extent of the services
• rate of VAT that applies to the items sold
• total amount payable – excluding VAT
• rate of any cash discount
• total amount of VAT charged.
VAT return
A VAT registered business must complete and file a VAT return, usually every quarter. To make sure you get your VAT return in on time you will need up to date accounting. Any good accounting system will sum up the input and output VAT and produce the figures that you need for the VAT return from the data that you’ve already entered. If the system is linked to HMRC (a one off set up exercise with a refresh every 18 months) then the VAT return can be filed with a simple click of a button. It’s as easy as that – if your record keeping is up to date.
VAT returns must be filed digitally through Making Tax Digital (HMRC’s flagship project for getting businesses to use digital systems for their accounting) compatible software.
Put simply, if your business is VAT registered then you should be using an HMRC recognised accounting system to keep your records.
The VAT return is due seven days after the end of the month following the quarter-end date.
For example, if you have a VAT quarter end date of 31st March then the VAT return will be due by 7th May.
If you pay your VAT liability by Direct Debit this will be taken 10 days after the end of the month following the quarter-end date. So the direct debit will hit your business bank account on 10th May in the example.
VAT Schemes
There are several special schemes that you can use if you are VAT-registered, including:
• Annual Accounting
• Cash Accounting
• Flat Rate
• VAT retail
• VAT margin schemes
• Tour Operators Margin scheme.
More details on these schemes can be found on the GOV.uk web site. Getting tailored expert advice can ensure that you select the right VAT scheme for your business.
Tip – Although the Flat Rate Scheme used to be popular for those with limited costs seeking to simplify their VAT admin, a change implemented from 1 April 2017 means it’s become much less appealing. A limited cost business must use a flat rate of 16.5% rather than the flat rate percentage that applies to its industry. And because it’s applied to gross turnover, the effective rate of VAT paid to HMRC is 19.8%, so the benefit is just 0.2%. The net effect is that most limited cost businesses should either de-registered for VAT (if their turnover allows) or move to standard VAT accounting, meaning they account for VAT on their sales and purchases. You are a limited cost business if the amount you spend on VATable goods including VAT is either:
• less than 2% of your VAT Flat Rate turnover
• greater than 2% of your VAT Flat Rate turnover, but less than £1,000 per year (£250 per quarter)
The limited cost test applies only to goods and not services, with goods excluding things such as travel, rent, accountancy fees, insurance, etc.
Claiming VAT back prior to VAT registration
When you register for VAT you can go back over your previous purchases and claim the VAT back on goods your business bought or imported for up to four years before it was registered for VAT if the goods:
• were bought by you as the “person” who is now registered for VAT
• are for VATable business purposes (i.e. not VAT-exempt items you sell)
• are still held by you or they’ve been used to make goods you still hold
You can’t reclaim VAT on goods that you’ve completely used up before you registered for VAT (e.g. petrol, electricity or gas).
You cannot claim back the VAT for items already sold to customers.
You can claim back the VAT on services for up to six months before your business became VAT-registered.
Cancelling your VAT registration
If your business ceases to trade you must cancel your VAT registration. This must be done within 30 days or HMRC can charge a penalty.
If your business is shrinking and your VAT taxable turnover falls below £83,000 then you may decide to apply for your VAT registration to be cancelled. You can do this by completing a form called a VAT7 or applying to do this online (see https://www.gov.uk/register-for-vat/cancel-your-registration).
Paying VAT
Any VAT due must be paid by the date shown on your VAT return. Ways to make a VAT payment can be found at https://www.gov.uk/pay-vat.
Where can I get more information?
If you need more help about any aspect of VAT then visit the GOV.uk web site, read the VAT guide (known as the VAT Notice 700) or seek advice from a suitably qualified VAT professional or accountant.
VAT top hints and tips
- VAT is complicated. All but the very simplest of businesses may need advice from an expert when it comes to their VAT affairs
- Being registered for VAT means that you are an unofficial tax collector – you collect the output VAT on your sales and pay it over to HMRC after deducting the input VAT that you have paid on any purchases made
- Do not spend your VAT money – it is not yours and belongs to HMRC. Many a business fails when it props up its cashflow by dipping into the VAT pot due to be paid to HMRC. The best approach is to ring fence this money and not touch it
- If you register late for VAT you are likely to incur a fine or penalty. So keep an eye on your turnover and made sure that you register before you exceed the threshold
- Keep your business simple and avoid voluntarily registering for VAT unless there is a good reason to do so like a regular VAT refund being due that would more than outweigh the costs of administering the VAT accounting