Value Added Tax (VAT) and your business
VAT is a tax ultimately paid by the final consumer and businesses act as the collectors of the tax. There are heavy fines for failing to operate the system properly.
What does VAT apply to?
VAT is chargeable on the supply of goods and services in the UK when made by a business that is required to register for VAT.
A registered business must charge VAT on its sales which is known as output VAT. There are currently three rates of VAT which can be payable on what are known as taxable supplies. These are the standard rate of 17.5%, the reduced rate of 5% and zero rate.
Zero rate is where the supply is deemed to be subject to VAT but the output VAT is charged at 0%, meaning that no VAT would be payable.
However a business also pays VAT on the goods and services it buys. This is known as input tax.
If the output tax exceeds the input tax, then a payment of the difference has to be made to HMRC. This calculation is normally done quarterly. If input tax exceeds output tax a repayment of VAT will be made. This calculation is also done quarterly except that if repayments occur regularly this can be done monthly. Regular repayments would perhaps apply where a business generally makes zero rated supplies.
Supplies
Certain supplies of goods and services are not subject to VAT at all and are known as exempt supplies. A business that makes only exempt supplies cannot register for VAT and will be unable to reclaim any input tax.
Tax Tip
When you first register for VAT you can reclaim input tax on goods purchased up to three years prior to registration provided they are still held when registration takes place. VAT on services supplied in the six months prior to registration may also be reclaimed.
As there are three rates which can be applicable to taxable supplies, standard, reduced or zero rated, it is important to identify the type of supplies correctly and apply the correct percentage of VAT.
Some input VAT is not reclaimable by a VAT registered business. Two common examples are VAT incurred on entertaining business customers and VAT on the purchase of a car.
Do I need to register?
A business must register if its taxable supplies exceed an annual figure, currently £70,000. If taxable supplies are less than this a business may still register voluntarily. So, for example, if the business makes only zero rated sales, it can still register and reclaim the input tax suffered.
VAT can affect competition. A plumber, for example, who sells only to the general public, will be at a disadvantage if he has to register for VAT. He may have to charge up to 17.5% more than a plumber who is not registered to earn the same profit. On the other hand, if the same plumber only works for other VAT registered businesses, such as building companies, then it will not matter if they are registered because the customer will be able to recover the VAT that is charged.
Indeed, in general, a business that always sells to other VAT registered businesses will normally register, even if below the annual limit, because then it can reclaim VAT on purchases and expenses. This will improve profit. This can be especially relevant for new businesses because there are often high start up costs that carry VAT.
On the other hand registration comes at the cost of having to meet onerous record-keeping requirements, a need to submit VAT returns on time and a fundamental need to get it right! Failure on any of these points exposes the business to penalties which, in some cases, can be substantial.
Schemes for a small business
The Flat Rate Scheme
This scheme, designed to make the VAT system simpler, is open to a business whose annual taxable supplies are less than £150,000. It allows a business to pay VAT at a fixed percentage of their total turnover and no specific claims to recover input tax need to be made. The fixed percentage depends on the type of business.
The Cash Accounting Scheme
If annual taxable supplies are less than £1,350,000, a business may calculate its VAT payable by considering only the output tax and input tax on invoices which have been received/paid, rather than by reference to the invoice date alone. This is advantageous where a business has to wait a long time before it is paid by its customers.
The Annual Accounting Scheme
If taxable supplies are below £1,350,000 a business may choose to make only one annual return instead of quarterly returns. Interim payments of VAT must be made monthly or quarterly by direct debit based on an estimate of the amount due.
VAT is a tax full of pitfalls for the unwary but most problems arise from poor record keeping or a lack of understanding of the rules. We can help with both of these issues and make your life a lot simpler.
Tax Planning
You should consider carefully whether to register voluntarily. If the VAT at stake is relatively small the responsibilities of registering may outweigh the benefit. For help in making this decision please contact us.
