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.
VAT – or Value Added Tax – is a consumption tax 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, certain things are zero-rated, like food, books, newspapers and magazines, young children’s clothing and footwear, but I wouldn’t worry about these for now.
Registration for VAT is compulsory when the annual turnover of your business reaches a set amount – this is currently set at £85,000. You must keep a close eye on your turnover if you think it might 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.
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 on 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 that prevented you from submitting your application on time.
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. 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.
However, it is worth remembering 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.
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.
While waiting for your VAT certificate, you will need to raise your invoices as a total figure, including 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 it to your customers – who will then be able to reclaim the VAT you have charged.
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:
Once you register, you will receive the following:
You will receive a certificate within 30 days of registration.
Here are some of the benefits of being VAT registered:
If you are VAT registered, you must submit a VAT return to HMRC quarterly to show how much VAT you are due to pay.
A VAT return must show 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. 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 entitled to a refund.
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.
Being registered on the standard scheme means you can reclaim VAT on purchases 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:
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.
Remember:
Even if you have not paid for goods purchased, you can still reclaim the VAT from HMRC in the quarterly VAT return, which is great for your cash flow.
You have to pay VAT over to HMRC for services or goods sold which you may have not yet received the money for. This isn't great for cash flow, especially for new businesses.
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.
Some limited company directors find Annual VAT Accounting easy as it allows you to budget and spread payments across the year.
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.
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.
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.
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.
VAT is one of the most complex and onerous tax regimes imposed on businesses. 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:
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