02 Apr VAT Guide for Beginners
Most purchases carry a VAT charge. Value Added Tax (VAT) is levied on most business transactions and on many goods and some services.
There are three rates of VAT in the UK:
- 20% (the ‘standard’ rate).
- 5% (‘reduced’ rate) and
- 0% (‘zero’ rate).
You will probably have to register for VAT if any of the following apply…
- The taxable turnover of your business in the previous 12 months reaches the VAT registration limit (£85,000 from 1/4/2017), although you can also register on a voluntary basis if your turnover is below this.
- You believe your turnover in the next thirty days will exceed the registration limit.
- You take over a business as a going concern whose turnover meets the conditions of the previous two points.
- You buy goods from elsewhere in the EU to a value above the registration limit in one calendar year.
There are penalties for failing to register on time.
Goods and services liable to VAT are known as ‘taxable supplies’. Once registered you must charge VAT on all taxable supplies.
VAT doesn’t apply to everything. Supplies which are specifically not subject to VAT are referred to as ‘exempt’ and include: insurance, financial services, postal services, health and education, although there are exceptions in every category.
The amount of VAT payable to Revenue and Customs is the difference between your output tax on your sales and input tax on your purchases. If input tax is greater than output tax, a refund may be owed. The VAT due is normally payable each quarter following the submission of a VAT return, although under certain schemes the payments can be made monthly.
Should you register?
If your taxable turnover is below £85,000 (from 1 April 2017) you don’t have to register but you may be eligible to apply for ‘voluntary registration’.
There can be advantages in registering such as…
- increased business credibility;
- potential savings if your supplies are zero rated but you can still reclaim VAT on your purchases;
- potential savings if you mainly supply other VAT registered businesses who don’t mind being charged VAT and you can then still reclaim VAT on your purchases.
This does however have to be weighed up against the hassle factor of completing VAT returns, and paying the VAT due every quarter. If you supply the general public you will probably not want to register as this simply puts your prices up by the rate of VAT.
There are various VAT schemes, mainly for small businesses…
- Cash accounting – If your taxable turnover is under £1,350,000 a year you can arrange to account for VAT on the basis of cash received and paid, rather than the invoice date or time of supply.
- Annual accounting – You can complete one VAT return per year rather that four if your turnover is under £1,350,000. You must also make nine payments on account throughout the year, and a balancing payment with the VAT return.
- Flat rate scheme – This is for businesses with a turnover of under £150,000 and saves on administration as you just pay a set percentage of your VAT inclusive turnover based on your business sector rather than accounting for VAT on each individual “in and out”. It can also reduce the VAT you pay in some situations.
- Retail schemes – These apply to retailers and offer an alternative if it’s not practical to issue invoices for a large number of supplies direct to the public.
VAT Annual Accounting
With the Annual Accounting Scheme you complete one VAT return per year instead of each quarter.
The advantages of using the scheme are that…
- Only one VAT return is required per year and you have two months in which to complete it.
- Cash flow is helped by regular monthly payments.
- You can choose the VAT return year that you want.
It is usually necessary to make nine equal interim VAT payments by direct debit at monthly intervals during the year. The amount of the interim payments are based on an estimate of your total VAT liability based on your previous 12 months net payment of VAT. A balancing payment is made when the annual return is filed. You can also apply for quarterly payments that are 25% of the provisional VAT liability.
You do have to be careful not to build up a large unexpected balancing payment, so you need to monitor your total VAT liability over the year. The annual accounting scheme is also not good for any business with regular repayments of VAT as it then takes over a year to get your money.
To qualify to use the scheme…
- If your annual taxable turnover is not expected to exceed £1,350,000 you can join at any time after registering for VAT
- You do not belong to a VAT group, or are a registered as a division of a company.
You can continue to use the scheme until your annual taxable turnover reaches £1,600,000.
VAT Cash Accounting
Under the cash accounting scheme you account for VAT on the basis of payments you receive and make, rather than on invoices you issue and receive. The main benefit of this scheme is that you don’t have to pay VAT on invoices you have issued until your customers pay you, although it also means you can’t reclaim VAT on purchases until you pay your suppliers. You get automatic bad debt relief because, if no payment is received, no output tax is due.
Who can use the scheme?
You can choose this scheme if you expect the value of your taxable supplies (excluding VAT) during the next year (beginning at the start of a tax period) will not exceed £1,350,000 and…
- you have sent in all the VAT returns due at the time you start to use the scheme;
- you have not been convicted of a VAT offence in the last year;
- you have not received a penalty for VAT evasion involving dishonest conduct in the last year
- you do not owe any VAT or you have made arrangements with Revenue and Customs to clear the total amount of your outstanding VAT payments (including surcharges and/or penalties);
Your business can continue using the scheme until its annual taxable turnover reaches £1,600,000. You may use the cash accounting basis for a further six months to account for any VAT outstanding on supplies made and received while using the scheme, or you can account for all the outstanding VAT due in the period you cease to use the scheme. Any VAT still outstanding at the end of the six month period must be accounted for on the VAT return ending then.
You don’t need to apply to use this scheme, and you can change to it at the beginning of any tax period. If your business is already registered for VAT when you start, you must make sure you don’t account for VAT twice on any supplies made or received previously. You cannot retrospectively apply the cash accounting scheme to your business.
The cash accounting scheme can be used together with the annual accounting scheme, or flat rate scheme for small businesses.
VAT Flat Rate Scheme
The VAT flat rate scheme is designed to make it simpler and quicker for small businesses to complete their VAT return.
This is because VAT payable to HMRC is calculated as a particular percentage of the gross turnover of the business and not as the difference between VAT on individual sales and purchases. In particular there is no need to record the VAT incurred on most purchases and determine whether it is reclaimable or not, so there is less chance of error. The amount of VAT charged to customers remains the same whether using the flat rate scheme or not.
However, some business will pay less VAT by using the scheme and some may pay more by using it as the percentages used are based on the average VAT payable by particular trade sectors. It is important to calculate the financial effect before applying to use the scheme.
The Flat Rate Scheme Calculation
These are the steps in the calculation…
- The output VAT for a VAT return is established by multiplying the VAT-inclusive turnover by a fixed percentage which is determined by the sector in which the business operates. This goes in Box 1 on the return.
- All turnover is included in the taxable supplies it has made, whether standard, reduced, zero rated or even exempt and it is the gross turnover. This figure goes into Box 6.
- Usually no VAT can be reclaimed on purchases but there are exceptions for any VAT on purchases before the business was registered and VAT and on a single capital asset that costs over £2,000 inclusive of VAT can be reclaimed. The VAT on these goes in Box 4 as usual and the net amount of the purchase in Box 7.
So if for example your gross turnover comes to £20,000 and the percentage for the sector is 10%, the VAT due is £2,000. If what you purchased was a capital asset for £3,833 including £500 of VAT, then the VAT payment due would be £1,500.
To qualify to join the scheme…
- A business must have a taxable turnover, excluding VAT, of no more than £150,000 a year. The taxable turnover is the total value of supplies or sales made by the business that are liable to a VAT whether at standard, reduced or zero rates, but excluding any expected sales of capital assets.
- A business must not already use the second hand goods, the tour operators or retail schemes.
- The business must not be required to use the capital goods scheme for certain capital items.
- A business must not have been found guilty of a VAT offence in the past year or be associated with another business or registered as part of a VAT group in the past 2 years.
A business must apply to join the flat rate VAT scheme and can leave whenever it chooses by informing HMRC in writing.
From April 2017, the government will introduce a new 16.5% rate for businesses with limited costs, such as many labour-only businesses. This will help level the playing field, while maintaining the accounting simplification for the small businesses that use the scheme as intended
The Business Sector Flat Rates
Different business sectors must use their own flat rate.
A business must choose its sector on the grounds that it most closely describes its main trading activities. If the trading mix changes, so say the majority of the turnover comes from supplying restaurant meals rather than alcoholic drinks the trade sector to be used will change from ‘Pubs’ (6.5%) to ‘Catering Services’ (12.5%). The change in sector should be made from the start of the VAT period that contains the anniversary of joining the scheme.
It is advisable to set out in writing why you made the selection of trade sector.
1% Reduction in First Year of VAT Registration
In your first year of VAT registration there is a 1% reduction in the flat rate that is applied to your turnover. The reduction is for the 12 months following the date of VAT registration and not the date of joining the flat rate scheme. There is no entitlement to the 1% reduction if you register for VAT 12 months after you were required to register.
A Trap in the Flat Rate Scheme
The flat rate must be applied to all business income, including rents and sales of assets where VAT was not reclaimed, such as cars or property, but not interest received from business bank accounts. This means you effectively pay VAT on the gross receipts of sales on which you have not collected any VAT.
If you are a sole-trader the flat rate should be applied to any letting income you receive in your sole name, as lettings are regarded as a business for VAT purposes. Lettings undertaken as a partnership, perhaps jointly with your spouse, are not counted as part of your sole-trader business income. When you sell a let property the flat rate should be applied to the total proceeds. You can withdraw from the flat rate scheme before you sell a high value item such as a property, but you have to stay out of the scheme for at least 12 months.
How We Can Help You
We can assist you with…
- Registering for VAT – VAT Accountants London
- Advising on suitability of VAT schemes
- Assisting with completion of VAT returns
- Setting up your accounting system to deal with VAT
- Representing you in any disputes with HM Revenue & Customs
- Providing VAT planning advice for complex transactions such as when buying property.