VAT guide
As a contractor, you may find that registering for VAT could save you money. But there are a few different VAT schemes available to you. Since there are different schemes available, it's worth considering which one is best for your business and your cashflow.
Do I need to register for VAT?
If your annual turnover exceeds £85,000 then it is mandatory that you register. However, you can do so voluntarily at any point. You can find out more about your responsibilities in our VAT basics guide.
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 |
|---|
You must include the invoice in the quarter the invoice was raised, not the month the payment was received.
Remember:
- 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.
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The Flat Rate VAT Scheme
The Flat Rate VAT Scheme is an incentive provided by the government to help simplify taxes and means you charge VAT on your invoices at 20% but only pay back HMRC at a lower rate. Unlike the Standard VAT accounting, you can only join the Flat Rate VAT Scheme if your annual taxable turnover (not including VAT) is £150,000 or less.
This provides the following additional income (based on a 45-week working year):
- £200 per day contract - £630 extra per year
- £350 per day contract - £1,102.50 extra per year
- £600 per day contract - £1,890 extra per year
The Flat Rate VAT Scheme is the chosen scheme for most contractors, freelancers, consultants and Interim Managers. It is also the scheme that is recommended for businesses that have very few VAT chargeable purchases and expenses i.e. don’t buy much stock. It simplifies your VAT accounting and is intended to be an admin saving tool for small business.
The Flat Rate VAT percentage you pay is lower than that of the standard VAT rate. Most contractors will be Limited Cost Traders. A Limited Cost Trader is a company whose expenditure on goods is less than 2% of the VAT inclusive turnover or less than £1,000. Visit our Flat Rate VAT Scheme guide page for a full list of the flat rates depending on your profession. See example below based on a Limited Cost Trader in the first year of trade:
| Description | Value |
|---|---|
| The net amount you invoice your client | £5,000 |
| VAT charged on top to your client (20%) | £1,000 |
| Gross Amount | £6,000 |
| Flat rate VAT 15.5% (this includes a first-year discount of 1%) | 15.5% |
| VAT to be paid to HMRC – 13.5% of £6,000 | £930 |
| VAT received from the client | £1,000 |
| Profit for you i.e. what you get to keep | £70 |
However, there are certain thresholds which cannot be exceeded, for more information see our detailed Flat Rate VAT Scheme Guide.
The Cash Accounting Scheme
This scheme cannot be used if your annual turnover is more than £1.35 million. 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. Likewise, with goods (like stock) bought for their own company, they cannot ask to reclaim VAT if they themselves have not paid for the goods.
Each quarter you will be asked to fill in your VAT return form for HMRC (online only) stating your output tax and input tax (very similar to that of the standard VAT), 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) |
|---|---|---|
| T11th 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
- 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
- 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, so make sure to discuss all your VAT scheme options with your accountant before deciding.
Annual VAT Accounting
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
- Some limited company directors find Annual VAT Accounting easy as it allows you to budget and spread payments across the year.
Disadvantages
- 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.
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