- Original Poster
- #1
HOW VAT WORKS
For the layman, VAT can be quite complicated and the technicalities can even confuse the very clever individual.
Therefore, I have created an easy to follow guide for the basics for the UK VAT system.
First of all, what is VAT?
If you are a VAT registered business you may need to add VAT to your services/sales.
The standard VAT rate in the UK is currently 20%.
Certain services and goods fall outside UK VAT such as insurance (taxed through the insurance industry) and flights (taxed through the aviation industry) as well as other items such as rail fares, postages, bank charges, certain training/teaching costs, foods, children’s clothing and other items seen as `essentials’ and therefore not subject to sales tax (VAT).
A business can voluntary register for VAT however if its annual turnover in the previous twelve months is over (currently) £85,000 it is compulsory to register for VAT and you must do so within 30 days after reaching this level of turnover.
Nowadays, VAT registration for a business can be applied for online unlike the old paper forms of years gone by and it is a much quicker turnaround time registering for VAT than the old paper registration forms sent through the post to HMRC.
Once the registration form is submitted is ordinarily takes two working days to receive your VAT number and four days to be able to access your VAT registration certificate.
As a VAT registered business, clients may request to see your VAT certificate.
The registration threshold also changes most years therefore if you are near the turnover threshold and are not yet registered you should keep your eye on this on an annual basis.
When you are registered for VAT and you are supplying VAT chargeable services or goods you need to add VAT on your invoices at 20%.
If your customers are VAT registered themselves they can reclaim the VAT however if you are invoicing customers e.g. individuals who are not VAT registered your VAT charge will be an extra charge to them on top of your services therefore this is something to bear in mind if you are invoicing customers who are not VAT registered themselves. If this makes you uncompetitive compared to rival businesses you may need to reduce your charges accordingly to stay competitive.
It is also worth noting as a contractor it can be seen as more official and it gives more credibility if your company is actually registered for VAT rather than not being. In addition when quoting for work some companies mandate that suppliers must be limited and be VAT registered.
Before registering for VAT it is worth having a chat with your accountant who can advise you what is best in your particular circumstance.
The day that you register with HM Revenue and Customs for VAT is the day you must start charging VAT on all your goods and services.
If you need to raise an invoice to a customer/client and you do not yet have your VAT number you cannot charge VAT however should raise your invoice showing your charges/sales and add a footnote to this that reads `a VAT only invoice in respect of these charges will be issued at a later date once VAT registration details have been received’. Then in due course, once you receive your VAT number you can raise a VAT only invoice cross-referring to the original invoice(s) where you did not charge VAT.
Going forward, every quarter (three months) depending on when your VAT periods are set (they could end a) 31 January, 30 April, 31 July and 31 October or b) 28 February, 31 May, 31 August and 30 November or c) 31 March, 30 June, 30 September and 31 December), you must submit a VAT return to HMRC (this is now done online and from 1 April 2019 this is now done via Making Tax Digital which requires the VAT return to be submitted via some Making Tax Digital compliant software e.g. FreeAgent, Xero etc) and make any necessary payment to them.
VAT on your sales/services is technically known as `output’ tax and VAT on your purchases/expenses is known as `input’ tax.
The VAT return contains nine boxes that need completing and for the `normal’ contractor they will only complete box 1 (VAT on sales –output tax), box 4 (VAT on purchases/expenses –input tax), box 6 (net sales -outputs) and box 7 (net purchases/expenses -inputs). Box 5 is the amount payable to or refundable by HMRC (this is effectively box 1 less box 4).
One of the main advantages of registering for VAT (if you are charging VAT registered customers) is that you can reclaim the VAT on any VAT inclusive costs therefore the cost of these to your business is the actual net figure before VAT.
A VAT registered business has a month and seven days to submit its VAT return and pay the required liability to HMRC (if there is an amount payable) and an extra three days is given if you pay HMRC via direct debit. Therefore, if your VAT return period ended on 30 June 2019 you would have until 7 August 2019 to file the return and pay the liability or if you had a direct debit set up with HMRC the liability would go through on or around 10 August 2019.
If the VAT on purchases/expenses exceeds the VAT on your sales in any particular VAT quarter, HMRC will refund the company.
As mentioned, customers/clients that are VAT registered can reclaim the VAT that you charge them -this is not necessarily an advantage for you but it does however create a more professional image and the customer may then be more inclined to use your business again in the near future knowing that you are VAT-registered and that they can possibly reclaim their input tax also.
Your accountant will ordinarily take care of your VAT registration for you and this is one of the first tasks they will carry out when you set up a new company.
HMRC operate different VAT schemes to suit different business:
1. Standard VAT scheme -you invoice your customers at the standard rate, and pay VAT to HMRC based on the total amount of VAT you have charged on invoices raised during the VAT period, minus any VAT that you have paid out on purchases/expenses paid out by your business.
2. Cash Accounting scheme -this is the same as the above however you only pay VAT to HMRC once you have actually received the funds from your customers and clients. Similarly, you can only reclaim VAT on purchases/expenses when you have actually paid the supplier for them. This can be useful for cashflow purposes and most contractors who are VAT registered operate under the cash accounting scheme.
3. Flat Rate VAT scheme -this is a scheme which was often used by limited company contractors previously however not so much nowadays as it is no longer as beneficial. It was originally designed to make accounting easier. Under this scheme you would still invoice clients at the standard rate, but you pay HMRC a fixed percentage rate of your gross quarterly turnover, depending on the industry that you operate in. For IT contractors, the rate is 14.5%, and in the first year of operation, the contractor can benefit from a 1% reduction to the fixed rate. Please note however that from April 2017, the new ‘limited cost trader’ rules have removed the majority of the benefits of using the VAT Flat Rate VAT scheme for the majority of small businesses, particularly those with low quarterly costs.
Your accountant will be able to advise you which scheme is most suitable for you and nowadays it is more beneficial for contractors to operate under the `normal’ (not VAT Flat Rate) scheme on a cash accounting basis.
When you are VAT registered you are required to include your VAT number on your invoices to your customers/clients.
VAT penalties
The penalties for non-registration or late registration, and late payment of VAT liabilities can be fairly hefty therefore it is important that you make sure you (and your accountant) keep on top of your company’s tax and VAT accounting.
For various reasons it is possible that a contractor may miss a VAT filing deadline. If this occurs the business will receive a letter to the effect that the business is placed on to a `warning’ for the next twelve months. Providing the VAT returns and payments are all submitted to HMRC on time in the next twelve months, the `warning’ will be removed. However, if the company/business is late again within twelve months HMRC will write again and place the business onto the second level of `warning’. Repeated lateness within twelve months of the last late return result in the warning level moving up and after four or five of these HMRC will start charging financial penalties (2%, 5%, 10% and a maximum 15% of the actual VAT liability would be charged on top of the actual VAT liability payable) for repetitive late returns. In order to ensure that any warning level is removed you need to ensure that your returns and payments are submitted on time for a consecutive twelve months.
It is clearly in your best interests to avoid these penalties, and in addition, increased scrutiny from HMRC may take a closer look into your affairs, therefore you should make sure you that you or your accountant are processing your VAT returns on time, and you could set up a direct debit in order that you will not ever miss a payment.
For the layman, VAT can be quite complicated and the technicalities can even confuse the very clever individual.
Therefore, I have created an easy to follow guide for the basics for the UK VAT system.
First of all, what is VAT?
If you are a VAT registered business you may need to add VAT to your services/sales.
The standard VAT rate in the UK is currently 20%.
Certain services and goods fall outside UK VAT such as insurance (taxed through the insurance industry) and flights (taxed through the aviation industry) as well as other items such as rail fares, postages, bank charges, certain training/teaching costs, foods, children’s clothing and other items seen as `essentials’ and therefore not subject to sales tax (VAT).
A business can voluntary register for VAT however if its annual turnover in the previous twelve months is over (currently) £85,000 it is compulsory to register for VAT and you must do so within 30 days after reaching this level of turnover.
Nowadays, VAT registration for a business can be applied for online unlike the old paper forms of years gone by and it is a much quicker turnaround time registering for VAT than the old paper registration forms sent through the post to HMRC.
Once the registration form is submitted is ordinarily takes two working days to receive your VAT number and four days to be able to access your VAT registration certificate.
As a VAT registered business, clients may request to see your VAT certificate.
The registration threshold also changes most years therefore if you are near the turnover threshold and are not yet registered you should keep your eye on this on an annual basis.
When you are registered for VAT and you are supplying VAT chargeable services or goods you need to add VAT on your invoices at 20%.
If your customers are VAT registered themselves they can reclaim the VAT however if you are invoicing customers e.g. individuals who are not VAT registered your VAT charge will be an extra charge to them on top of your services therefore this is something to bear in mind if you are invoicing customers who are not VAT registered themselves. If this makes you uncompetitive compared to rival businesses you may need to reduce your charges accordingly to stay competitive.
It is also worth noting as a contractor it can be seen as more official and it gives more credibility if your company is actually registered for VAT rather than not being. In addition when quoting for work some companies mandate that suppliers must be limited and be VAT registered.
Before registering for VAT it is worth having a chat with your accountant who can advise you what is best in your particular circumstance.
The day that you register with HM Revenue and Customs for VAT is the day you must start charging VAT on all your goods and services.
If you need to raise an invoice to a customer/client and you do not yet have your VAT number you cannot charge VAT however should raise your invoice showing your charges/sales and add a footnote to this that reads `a VAT only invoice in respect of these charges will be issued at a later date once VAT registration details have been received’. Then in due course, once you receive your VAT number you can raise a VAT only invoice cross-referring to the original invoice(s) where you did not charge VAT.
Going forward, every quarter (three months) depending on when your VAT periods are set (they could end a) 31 January, 30 April, 31 July and 31 October or b) 28 February, 31 May, 31 August and 30 November or c) 31 March, 30 June, 30 September and 31 December), you must submit a VAT return to HMRC (this is now done online and from 1 April 2019 this is now done via Making Tax Digital which requires the VAT return to be submitted via some Making Tax Digital compliant software e.g. FreeAgent, Xero etc) and make any necessary payment to them.
VAT on your sales/services is technically known as `output’ tax and VAT on your purchases/expenses is known as `input’ tax.
The VAT return contains nine boxes that need completing and for the `normal’ contractor they will only complete box 1 (VAT on sales –output tax), box 4 (VAT on purchases/expenses –input tax), box 6 (net sales -outputs) and box 7 (net purchases/expenses -inputs). Box 5 is the amount payable to or refundable by HMRC (this is effectively box 1 less box 4).
One of the main advantages of registering for VAT (if you are charging VAT registered customers) is that you can reclaim the VAT on any VAT inclusive costs therefore the cost of these to your business is the actual net figure before VAT.
A VAT registered business has a month and seven days to submit its VAT return and pay the required liability to HMRC (if there is an amount payable) and an extra three days is given if you pay HMRC via direct debit. Therefore, if your VAT return period ended on 30 June 2019 you would have until 7 August 2019 to file the return and pay the liability or if you had a direct debit set up with HMRC the liability would go through on or around 10 August 2019.
If the VAT on purchases/expenses exceeds the VAT on your sales in any particular VAT quarter, HMRC will refund the company.
As mentioned, customers/clients that are VAT registered can reclaim the VAT that you charge them -this is not necessarily an advantage for you but it does however create a more professional image and the customer may then be more inclined to use your business again in the near future knowing that you are VAT-registered and that they can possibly reclaim their input tax also.
Your accountant will ordinarily take care of your VAT registration for you and this is one of the first tasks they will carry out when you set up a new company.
HMRC operate different VAT schemes to suit different business:
1. Standard VAT scheme -you invoice your customers at the standard rate, and pay VAT to HMRC based on the total amount of VAT you have charged on invoices raised during the VAT period, minus any VAT that you have paid out on purchases/expenses paid out by your business.
2. Cash Accounting scheme -this is the same as the above however you only pay VAT to HMRC once you have actually received the funds from your customers and clients. Similarly, you can only reclaim VAT on purchases/expenses when you have actually paid the supplier for them. This can be useful for cashflow purposes and most contractors who are VAT registered operate under the cash accounting scheme.
3. Flat Rate VAT scheme -this is a scheme which was often used by limited company contractors previously however not so much nowadays as it is no longer as beneficial. It was originally designed to make accounting easier. Under this scheme you would still invoice clients at the standard rate, but you pay HMRC a fixed percentage rate of your gross quarterly turnover, depending on the industry that you operate in. For IT contractors, the rate is 14.5%, and in the first year of operation, the contractor can benefit from a 1% reduction to the fixed rate. Please note however that from April 2017, the new ‘limited cost trader’ rules have removed the majority of the benefits of using the VAT Flat Rate VAT scheme for the majority of small businesses, particularly those with low quarterly costs.
Your accountant will be able to advise you which scheme is most suitable for you and nowadays it is more beneficial for contractors to operate under the `normal’ (not VAT Flat Rate) scheme on a cash accounting basis.
When you are VAT registered you are required to include your VAT number on your invoices to your customers/clients.
VAT penalties
The penalties for non-registration or late registration, and late payment of VAT liabilities can be fairly hefty therefore it is important that you make sure you (and your accountant) keep on top of your company’s tax and VAT accounting.
For various reasons it is possible that a contractor may miss a VAT filing deadline. If this occurs the business will receive a letter to the effect that the business is placed on to a `warning’ for the next twelve months. Providing the VAT returns and payments are all submitted to HMRC on time in the next twelve months, the `warning’ will be removed. However, if the company/business is late again within twelve months HMRC will write again and place the business onto the second level of `warning’. Repeated lateness within twelve months of the last late return result in the warning level moving up and after four or five of these HMRC will start charging financial penalties (2%, 5%, 10% and a maximum 15% of the actual VAT liability would be charged on top of the actual VAT liability payable) for repetitive late returns. In order to ensure that any warning level is removed you need to ensure that your returns and payments are submitted on time for a consecutive twelve months.
It is clearly in your best interests to avoid these penalties, and in addition, increased scrutiny from HMRC may take a closer look into your affairs, therefore you should make sure you that you or your accountant are processing your VAT returns on time, and you could set up a direct debit in order that you will not ever miss a payment.
