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Understanding Value Added Tax (VAT) is crucial for small businesses in the UK. VAT is a type of tax that is levied on the sale of goods and services, and it can have a significant impact on a business’s bottom line. But do small businesses need to pay VAT? The answer to this question depends on various factors, including the nature of your business, your annual turnover, and whether you trade with other countries.
In this comprehensive guide, we will explore these factors in detail, providing you with the information you need to understand your VAT obligations as a small business owner. From registration thresholds to VAT rates, and from filing returns to claiming VAT back, we’ve got you covered. Let’s dive in.
What Is VAT?
Value Added Tax, commonly known as VAT, is a type of tax that’s charged on most goods and services provided by VAT-registered businesses in the UK. It’s also charged on goods and some services that are imported from countries outside the UK, and goods coming from EU countries.
VAT is levied at each stage of the supply chain, from manufacturers to retailers, but it’s ultimately paid by the end consumer. Businesses charge VAT when they provide goods and services, and they pay VAT when they purchase goods and services for their business. If a business charges more VAT than it pays, it must pay the difference to HM Revenue and Customs (HMRC). If it pays more VAT than it charges, it can generally reclaim the difference from HMRC.
There are three rates of VAT: standard (20%), reduced (5%), and zero (0%). Different goods and services are charged at different rates. For example, most food and children’s clothes are zero-rated, while most digital services are standard-rated.
Understanding how VAT works is the first step towards managing your VAT obligations as a small business owner. In the following sections, we’ll delve into more specific aspects of VAT for small businesses.
Who Needs To Register For VAT?
Whether a small business or even a charity needs to register for VAT depends on its ‘taxable turnover’. Taxable turnover refers to the total value of everything you sell in a 12-month period that isn’t exempt from VAT. If your business’s taxable turnover exceeds the VAT registration threshold in a rolling 12-month period, you’re required to register for VAT. As of the time of writing, the VAT registration threshold is £85,000.
It’s important to note that this is not based on your profits or the size of your business, but on your total sales. So, even if your business is not making a profit, you may still need to register for VAT if your taxable turnover exceeds the threshold.
You may be wondering, “Do you pay VAT on the first £85,000?” The answer is no. VAT is not charged on your sales until you are VAT registered. Once you’re registered, you’ll need to charge VAT on all your applicable sales, regardless of the amount.
If you have two businesses, each business’s taxable turnover is considered separately for VAT registration. Therefore, setting up two businesses to avoid VAT registration would only be effective if the taxable turnover of each business is below the VAT registration threshold. However, if HMRC believes that the businesses were artificially separated to avoid VAT registration, they can insist that both businesses are VAT registered.
Sole traders must also register for VAT if their taxable turnover exceeds the threshold. The threshold applies to the combined turnover of all your businesses if you have more than one.
It’s also possible to register for VAT voluntarily if your turnover is below the threshold. This might be beneficial if you sell to other VAT-registered businesses, as they can reclaim the VAT, or if you want to reclaim the VAT on your purchases or imports.
How To Register For VAT?
Registering for VAT is a process that can be done online through the HM Revenue and Customs (HMRC) website. Here’s a step-by-step guide on how to register for VAT:
- Create a Government Gateway account: If you don’t already have one, you’ll need to create a Government Gateway account. This is a secure online system used to register for online services, file your tax return, and pay your taxes to HMRC.
- Fill out the VAT registration form: Once you have a Government Gateway account, you can fill out the VAT registration form. You’ll need to provide information about your business, including your business’s name, address, contact details, and details about your business activities.
- Provide information about your VAT taxable turnover: You’ll need to provide an estimate of your VAT taxable turnover for the next 12 months. This is the total value of everything you sell that isn’t exempt from VAT.
- Choose a VAT accounting scheme: There are several VAT accounting schemes to choose from, and the one that’s best for your business will depend on your individual circumstances. We’ll cover VAT accounting schemes in more detail in a later section.
- Submit the form: Once you’ve filled out the form and chosen a VAT accounting scheme, you can submit the form. HMRC will usually send you your VAT registration certificate within 30 working days.
It’s important to note that you can register for VAT without an accountant. However, some businesses choose to use an accountant for this process to ensure it’s done correctly.
Once you’re registered for VAT, you’ll need to charge VAT on your goods and services, file regular VAT returns, and pay any VAT due to HMRC.
In the UK, understanding the different VAT rates is crucial for small businesses. As part of our guide on ‘VAT for Small Businesses’, we explain that there are three rates of VAT: standard, reduced, and zero. The rate you apply depends on the type of goods or services you provide
- Standard Rate (20%): The standard rate of VAT is currently 20%. This rate applies to most goods and services. If you’re a VAT-registered business, you’ll need to charge this rate on most of the goods and services you provide, unless they fall into the reduced or zero rate categories.
- Reduced Rate (5%): Some goods and services are charged at a reduced rate of 5%. This includes some types of energy-saving materials, children’s car seats, and home energy.
- Zero Rate (0%): Certain goods and services are zero-rated. This means that they’re still VAT-taxable, but the rate of VAT you must charge your customers is 0%. Zero-rated items include most food and children’s clothes.
It’s important to note that there are also some goods and services that are exempt from VAT or outside the VAT system altogether. If your business only sells goods or services that are exempt from VAT, you can’t register for VAT.
Understanding which VAT rate applies to your goods or services is crucial for charging your customers correctly and for completing your VAT return. In the next section, we’ll discuss the different VAT accounting schemes available to small businesses.
VAT Accounting Schemes
VAT accounting schemes are special schemes designed to simplify VAT accounting for small businesses. They can make it easier to manage your cash flow and reduce the amount of paperwork. Here are some of the main schemes available:
- Standard VAT Accounting: This is the default method of accounting for VAT. You pay VAT on your sales when you invoice your customers, and you reclaim VAT on your purchases when you receive a VAT invoice from your supplier.
- Cash Accounting Scheme: If your turnover is £1.35 million or less, you can use the Cash Accounting Scheme. With this scheme, you only pay VAT to HMRC when your customers pay you, and you can only reclaim VAT on your purchases when you have paid your supplier.
- Flat Rate Scheme: If your turnover is £150,000 or less, you might benefit from the Flat Rate Scheme. With this scheme, you pay a fixed rate of VAT to HMRC and keep the difference between what you charge your customers and what you pay HMRC. You can’t reclaim VAT on your purchases, except for certain capital assets over £2,000.
- Annual Accounting Scheme: If your turnover is £1.35 million or less, you can use the Annual Accounting Scheme. With this scheme, you only need to submit one VAT return per year. You make advance payments towards your VAT bill based on your last return or estimated turnover.
- Retail and VAT Margin Schemes: These are specific schemes designed for businesses in the retail sector and businesses that sell second-hand goods, works of art, antiques, and collectors’ items.
Each scheme has its own rules and eligibility criteria, and not all businesses will benefit from using a scheme. It’s important to consider your business’s circumstances and consult with a VAT advisor or accountant if necessary.
Filing VAT Returns
As a VAT-registered business, you’re required to file VAT returns with HMRC, usually every three months. This period is known as your ‘VAT accounting period’. The VAT return shows how much VAT you are due to pay to HMRC, or how much VAT you are owed.
Here’s a brief overview of the process:
- Record your sales and purchases: You need to keep a record of all your sales and purchases during your VAT accounting period. This includes the amount of VAT charged on each sale or purchase.
- Calculate your VAT: At the end of each VAT accounting period, you need to calculate the amount of VAT you owe. This is done by subtracting the VAT you can reclaim on your purchases from the VAT you have charged on your sales.
- Submit your VAT return: You must submit your VAT return to HMRC online, even if you have no VAT to pay or reclaim. The deadline for submitting the return and paying any VAT you owe is one month and seven days after the end of your VAT accounting period.
- Pay any VAT due: If you owe VAT to HMRC, you must pay it by the deadline. If you reclaim more VAT than you pay, you’ll receive a refund from HMRC.
Failure to file your VAT return or pay any VAT due on time can result in penalties and interest charges, so it’s important to stay on top of your VAT obligations.
Claiming VAT Back
As a VAT-registered business, you can generally reclaim the VAT you’ve paid on purchases that are used for your VAT-taxable business activities. This is known as ‘input tax’. To reclaim VAT, you must keep accurate records of your business expenses and have valid VAT invoices for these purchases.
The amount of VAT you can reclaim must be included in your VAT return for the period in which the purchase was made. If the amount of VAT you reclaim is more than the VAT you owe on your sales, you’ll receive a refund from HMRC.
However, there are some purchases on which you can’t reclaim VAT, such as entertainment costs, some cars, and goods and services used for personal reasons. It’s important to understand the rules around reclaiming VAT to ensure you claim correctly and don’t face penalties.
Common VAT Mistakes
n the realm of ‘VAT for Small Businesses’, it’s crucial to be aware of common pitfalls. Misunderstandings and errors can occur, particularly given the complex nature of VAT regulations. This section aims to highlight some of these common mistakes, helping small businesses navigate VAT processes with greater confidence and accuracy.
- Not registering for VAT on time: If your taxable turnover exceeds the VAT registration threshold, you must register for VAT. Failure to do so can result in penalties.
- Incorrectly calculating VAT: VAT calculations can be complex, especially if you sell goods or services at different VAT rates. Using accounting software can help ensure your calculations are accurate.
- Not keeping accurate records: You must keep accurate and complete records of all your sales and purchases, including VAT invoices. These records are crucial for completing your VAT return and for reclaiming VAT on your purchases.
- Missing the VAT return deadline: VAT returns must be submitted and any VAT due must be paid by the deadline. Missing the deadline can result in penalties and interest charges.
VAT for Small Businesses Post-Brexit
Brexit has brought about changes to VAT that affect small businesses. For example, the introduction of import VAT on goods entering the UK from the EU, and changes to the ‘place of supply’ rules for services. Understanding these changes is crucial for small businesses to ensure compliance and effective operations. For a more detailed understanding of post-Brexit VAT changes, you can refer to our comprehensive guide on ‘Post-Brexit VAT Changes‘.
Understanding VAT is crucial for small businesses. From knowing when to register for VAT, to understanding how to calculate and reclaim it, VAT can seem complex, but with the right knowledge, it can be managed effectively.
Whether you’re a sole trader or running a limited company, understanding your VAT obligations can help ensure your business remains compliant, avoids penalties, and manages cash flow effectively. Remember, if you’re unsure about anything related to VAT, it’s always a good idea to seek professional advice.
Resources And Further Reading
To further your understanding of VAT for small businesses and stay updated on the latest changes and trends, here are some resources and recommended readings:
- HM Revenue & Customs (HMRC): The UK’s tax authority provides up-to-date information on VAT rules and regulations.
- Federation of Small Businesses (FSB) VAT Guide: This guide from the FSB provides a comprehensive overview of VAT for small businesses.
- Startup Loans VAT Guide for Small Businesses: This guide provides a simple explanation of VAT and how it applies to small businesses.
- Simply Business VAT Guide: This guide covers the basics of VAT and provides advice on how to manage VAT as a small business.
- Xero VAT Guide: This guide from Xero, a popular accounting software provider, explains VAT and provides tips on how to manage it.
Remember, the key to successfully managing VAT is staying informed and seeking professional advice when needed. By doing so, you can ensure your business remains compliant with VAT rules and is well-prepared for any future changes.