“Make sure you pay your taxes; otherwise you can get in a lot of trouble.” – Richard M. Nixon
VAT is one of the major concerns and fears of business owners. This is due to the many complicated aspects of VAT and how it applies in different industries. There’s also the worry that you won’t be able to pay the VAT man on the required date! This may be due to late payments from customers, early payments to suppliers, or the VAT due date falling close to payroll. Being prepared is key when it comes to managing VAT. As Confucius said “A man who does not plan long ahead will find trouble at his door.”
VAT Registration Threshold
Whilst you can voluntarily register for VAT, registration is compulsory if your turnover exceeds £83,000 in the previous 12 months (tax year).
Once the business has been registered for VAT you can only charge VAT on goods or services that you sell. VAT is charged on:
- Business sales ie. when you sell goods and services
- Hiring or loaning goods to someone
- Selling business assets
- Items sold to staff eg. canteen meals
- Business goods used for personal reasons
- ‘Non-sales’ like bartering, part-exchange and gifts
Once you are a VAT-registered business, you must report to HM Revenue and Customs (HMRC) the amount of VAT you’ve charged and the amount of VAT you’ve paid. It is also a legal requirement to have your VAT registration number on your customer invoices and your website.
VAT is added to sales invoices, and purchase invoices will have VAT added if a supplier is VAT registered. Most items have VAT applied at the standard rate (currently 20%), however, some items are chargeable at a reduced rate of 5%, zero-rated (0%) or even be exempt.
Standard rate: Is currently set at 20% and is applied to all goods and services which do not fall into the other three categories.
Reduced rate: A rate of 5% that includes some goods, services and energy. Examples of where the reduced rate applies to business can be seen where builders may be able to charge the reduced rate of 5% for some types of work if it meets certain conditions, including installing energy saving products and certain work for people over 60, converting a building into a house or flats or from one residential use to another or renovating an empty house or flat. This can dramatically reduce a construction budget on a building project. Other activities where the reduced rate can be applied are repairs, cleaning and maintenance service and certain photographic supplies. A list of reduced rate activities are listed in Reduced Rate Activities (PDF, 101KB).
The second-reduced rate was introduced in July 2011 and has been extended indefinitely. It benefits restaurant and catering services; hotel and holiday accommodation; admissions to cinemas, theatres, certain musical performances, museums and art gallery exhibitions; fairgrounds or amusement park services; the use of sporting facilities; hairdressing services; printed matter such as brochures, maps, programmes, leaflets, catalogues and newspapers. All supplies of hot take-away food, including cooked chickens, are liable at the second reduced rate of VAT.
Zero rate: Is charged on most food (not restaurant or takeaway meals), children’s shoes and clothing, books and newspapers, new house sales and prescriptions. If the only goods you supply are zero-rated, you may not have to register to VAT – but you do have to apply for exemption from registration.
Exempt supplies: Includes education, finance, insurance, and the services of doctors and dentists (not some other services, such as osteopaths). There is no VAT charged on exempt supplies. If you only supply exempt services, you cannot usually register for VAT. However if you are VAT registered and have some exempt supplies, you may have difficulty claiming back all your input tax.
There can be ambiguities in the interpretation of the definitions of particular items and this can affect whether VAT is applied. This is evident in certain industries such as print where the description of an item can determine whether it is VATable or not; however, one person’s description of an item may vary from another’s. This has resulted in fierce debates between businesses and HMRC.
One example is the Jaffa Cakes case, which went to tribunal to determine whether they were classed as cakes or luxury biscuits. While cakes are exempt from tax, luxury biscuits are subject to VAT at the standard rate. McVities, the makers of Jaffa Cakes, insisted they were small cakes and eventually the tribunal ruled in favour of this.
HMRC publishes a list of goods and services showing which rates of VAT apply and which items are exempt or outside the scope of VAT. Such items include:
Food, animals, animal feed, plants, sports, leisure, health, education, power, energy, construction, transport, printing, postage, clothing, footwear, safety equipment and financial services. This is not an exhaustive list and more information can be found at https://www.gov.uk/guidance/rates-of-vat-on-different-goods-and-services
Record keeping and VAT returns
It is imperative to keep meticulous records for VAT returns, as it is for HMRC.
Your records should cover all business transactions, together with documents including bank statements, supplier invoices, customer invoices, receipts and cheque stubs to back up your records. It is also essential to separate your business transactions from your personal finances.
Many businesses choose to employ an accountant or book-keeper, to take control of their accounts and VAT, leaving them the time to get on with running their business, especially since there are severe penalties for failing to keep records. However, many cloud-based accounts packages such as Xero, Sage and Quickbooks have made accounts recording and VAT submission a simple process.
VAT returns are submitted quarterly on-line via the VAT Returns website. Output tax (on sales) and Input tax (on purchases) are netted and the difference – usually with outputs exceeding inputs – is paid over to HMRC. Where inputs exceed outputs, a repayment will be made by HMRC. Payments can be made in a variety of ways. See https://www.gov.uk/pay-vat for further information.
If you regularly pay out more VAT than you collect, you can fill in a return every month and claim a refund from the HMRC. See https://www.gov.uk/vat-repayments for further information.
VAT accounting schemes
There are several VAT accounting schemes which can make your life easier and in some cases improve your cash flow. We’ve written about the flat rate, cash accounting and annual accounting schemes in much more detail here, but in brief they are:
Flat Rate Scheme
You are only eligible for this VAT accounting scheme if your estimated taxable turnover in the following year will be £150,000 or less. VAT due is calculated as a percentage of your gross turnover rather than the difference between the actual VAT you have charged and paid.
Cash accounting scheme
You are only eligible for the VAT cash accounting scheme if your estimated taxable turnover is no more than £1.35m. This scheme lets you account for VAT on the basis of payments you have made and received, instead of on the basis of invoices issued.
As with the cash accounting scheme, you are only eligible if your estimated taxable turnover is no more than £1.35m. The scheme allows you to pay VAT on account, in either nine monthly or three quarterly payments. You then complete a single, annual VAT return which is used to work out any balance owed by you or due from HMRC.
Retail and VAT margin schemes
Various retail schemes exist to simplify VAT. The right scheme for you depends on whether your retail turnover (excluding VAT) is below £1m, between £1m and £130m or higher.
Smaller businesses may be able to use a retail scheme with cash accounting and annual accounting. You cannot combine a retail scheme with the flat rate VAT scheme, but retailers can choose to use the flat rate scheme instead.
For more information on retail and margin VAT schemes see:
You can register for VAT online at www.hmrc.gov.uk/vat. Registering for VAT can save you money and you can opt for voluntary VAT registration before they reach the limit. Remember, if you register for VAT you must keep your records for six years.
Deregistering from VAT
If the turnover of your business falls below a certain limit you can cancel your VAT registration. Currently, the deregistration limit stands at £81,000.
No matter which VAT scheme you use it is imperative you have the finance to pay your VAT bill and ensuring you have access to funds is crucial.
We hope this articles has provided you with all you need to know about VAT in business.
What has your experience of VAT been? Have you used any schemes?