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VAT-registration: the basics

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    Melissa Tredinnick

    Melissa Tredinnick UKBF Regular Staff Member

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    Since its introduction back in 1973, VAT has become notoriously complicated for businesses to deal with. 

    With different rates on different goods and services, complex rules for exports, and various accounting schemes to choose from, it’s no wonder that UKBF’s Accounts & Finance Forum is so frequently flooded with questions about calculating, reporting and paying VAT. 

    For business owners that get it wrong, the consequences can be severe. If you don’t realise your turnover has gone over the registration threshold for VAT, for example, you’ll still need to pay for the periods it was due – meaning you could find yourself facing a bill for thousands of pounds in unpaid tax that should have been charged to the customer.

    Added to that is the risk of a fine from HMRC if you file or pay late, or if your tax return contains inaccuracies. And, with Making Tax Digital (MTD) for VAT coming to the end of its soft-landing period in April, businesses may receive penalties if they don’t comply with the recently-introduced digital VAT requirements.

    As a starting point for anyone who’s new to VAT, this guide covers the very basics of the system. But if your taxable turnover is over the £85,000 VAT-registration threshold or likely to exceed it anytime soon, make sure you seek advice from a tax professional.

    How does VAT work?

    VAT stands for value-added tax, and is applied whenever ‘value is added’ to a product at each stage of the supply chain. It’s paid on the cost of the product, minus the costs of raw materials, goods and services used to produce it.

    Ultimately, the tax is paid by the consumer, but the seller calculates it, reports it and pays it to HMRC.

    For example, let’s say you’re running a floristry business and you’re registered for VAT. When you buy flowers, wire, ribbon and so on, the suppliers of those products will add VAT to their invoices. You can claim this back from HMRC, as ‘input tax’.

    When someone buys a flower arrangement from you, you’ll include VAT in your fee. This is ‘output tax’, and must be paid to HMRC.

    There are three different rates of VAT, depending on the goods or services you’re selling:

    • The standard rate of 20% applies to most goods and services. 
    • A reduced rate of 5% applies to certain goods and services, such as fuel and power, energy-saving measures, children’s car seats, and some mobility aids.
    • A zero-rate of 0% applies to most food, along with books, newspapers and children’s clothes.

    To make matters more complicated, some products and services are exempt from VAT – which is not the same as being zero-rated. 

    VAT-exempt goods and services include postage stamps, insurance, education and training, and selling or letting commercial land and buildings.

    The way different items are VAT-rated is complex and often bizarre, so if you’re not sure about the rating of items you’re selling, it’s often best to get advice.

    Registration and filing

    You’ll need to register for VAT if your taxable turnover goes over £85,000 within a rolling 12-month period. 

    This doesn’t have to be a tax year or a financial year – it could be any 12 months, so it’s important to check your turnover on a regular basis if you think you might go over.

    For help calculating your taxable turnover and registering for VAT, you can read HMRC’s guidance, here.

    Once you’re registered, you usually need to file a VAT return every three months, unless you’re using an accounting scheme that allows you to file differently. 

    VAT accounting schemes

    Depending on your business, certain VAT accounting schemes may be easier, and cheaper to run, than the standard method.

    The three main schemes you need to know about are the flat-rate scheme, the cash accounting scheme, and the annual accounting scheme.

    On the flat-rate scheme, businesses with a turnover of less than £150,000 (excluding VAT) are eligible to pay a fixed rate of VAT – generally between 4% and 14.5% depending on the sector your business operates in. With this scheme, you can’t reclaim the VAT on most purchases.

    This is designed to reduce the cost of VAT compliance, by removing the complexity of various tax rates. 

    There’s also the cash accounting scheme, which you can use as long as your taxable turnover is £1.35 million or less. This allows you to pay VAT on your sales when your customers pay you, as opposed to the date you send the invoice.

    However, you can’t reclaim the VAT on your purchases until you have paid your supplier.

    With the annual accounting scheme, you can make advance payments towards your VAT bill over the course of the year, and complete a single, annual VAT return. Again, your estimated taxable turnover should be no more than £1.35m to use this scheme.

    Digital VAT requirements

    Since 1 April 2019, most VAT-registered businesses have been brought into MTD for VAT – HMRC’s scheme to fully digitise the VAT system.

    This is something you need to consider if you’re about to register for VAT. The scheme makes it compulsory for businesses included to keep their records digitally, and submit VAT returns using software that’s able to connect with HMRC’s API.

    For most businesses, this means you’ll need to have some kind of compatible accounting software for your records and filing.

    Is your business about to go over the VAT-registration threshold? Have you found it difficult to get to grips with the system? Leave a comment below to share your thoughts.