A common question amongst small business owners is whether or not they should register for VAT and what is the Vat Threshold. Hopefully, this article will help you make up your mind about VAT registration, VAT Advantages & Disadvantages.
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Am I legally obliged to register?
If your turnover (total sales) in the previous 12 months exceeds the compulsory registration threshold (currently £79,000), then yes – you must register. Failure to do so can result in fines. If you are using online software such as XERO will keep an eye on this for you and warn you if you approach the threshold. It’s important to note that this is on a rolling 12-month basis (ie, the last 12 months from any given point), not based on turnover in a calendar year.
If you haven’t exceeded the threshold for compulsory registration you can still register voluntarily if it makes sense for you to do so.
How Does VAT work?
If you’re a VAT registered business then you are essentially an unpaid tax collector. You have to add VAT at the appropriate rate to everything you sell (usually at 20%). This additional income isn’t yours – you’re collecting it on behalf of HMRC (HM Revenue & Customs). Every 3 months you need to pay over the VAT you’ve collected to HMRC.
Now, here’s the good bit. When you buy items from another VAT-registered business – they have to charge you VAT. But you can claim this back.
So, let’s assume that in 3 months, you collect £1,000 in VAT from your customers. In the same period, you also buy something from a supplier and you’re charged £200 + VAT (Total: £240).
The amount you have to give to HMRC is the VAT you’ve collected (often called “Output VAT”) minus the VAT you’ve paid out (“Input VAT”). So in this example, you’ll be handing over £960 (1000 minus 40).
You’re essentially £40 better off than you would have been if you weren’t VAT registered.
Why Else Would I want to register?
Besides the possible financial gain, there are other advantages of registering for VAT due to which you might want to register for VAT:
By not being registered, you are telling the world that your company is turning over less than £79,000 a year. If you’re trying to present an image of being a big, established company then this would shatter that illusion to those in the know.
So Why Would I Not Want to Register for VAT?
After reading the above you could be forgiven if you’re already reaching for the registration forms. But hold on a minute. There can disadvantages to being VAT registered too.
The most often cited reason for not registering is the paperwork. This is an absolute codswallop. If you’re using decent accounting software (like Xero) then this isn’t an issue.
But imagine you sell widgets to people or businesses that aren’t VAT registered (ie, the public). You currently buy them for £7 (including the VAT of £1.17) and sell them for £10.
You currently make a profit of £3 on each sale. If you become VAT registered then you can claim that £1.17 back and now you’re making a profit of £4.17 per sale – and an increase of over 30%.
But you’re now VAT registered and you have to charge VAT on everything you sell. If you add VAT to your current selling price of £10, then you’ll be selling at £12. If your customers are VAT registered they won’t care as they can claim back the VAT. But if they’re not then the extra £2 has to come out of their pocket.
So essentially your prices are now higher which may mean your customers go to the other widget shop that is now cheaper than you.
You could absorb the VAT – i.e. still sell at £10, but have that as the VAT inclusive price (£8.33 + £1.67 VAT).
So let’s look at your profit again.
- You buy your widgets at £5.83 (you pay £7, but £1.17 can be claimed back)
- You sell them at £8.33 (you actually charge £10, but £1.67 goes to HMRC)
- So, you now make £2.50 (£8.33 minus £5.83) profit on each sale.
So Should I Register or Not?
If you sell mainly to non-VAT registered businesses/people, then perhaps not.
If you sell mainly to VAT-registered businesses then you probably should.
Even if you sell mainly to non-VAT registered businesses and decide not to register for VAT yourself, then do remember that if your turnover gets high enough (and we hope it will!) then you’ll be legally obliged to register.
A couple of other important things that may affect your decisions are whether the products you supply are “Zero-rated” for VAT and whether your main suppliers/customers are outside of the UK – but that is outside the scope of this article.
Different VAT Schemes Available
If you do decide to register for VAT, you should be aware that there are several schemes available. These are the 3 most popular.
Standard (or Accrual) Scheme
On the standard scheme, the amount of VAT you owe (or reclaim) is based on the date of invoices. So if you invoice someone for £1,000 + VAT – that VAT is deemed to be owed to HMRC at the end of the quarter in which you dated the invoice. This can cause cashflow problems for small businesses.
Cash Accounting Scheme
This solves the cash flow problems associated with the Standard scheme. VAT is deemed to be owed at the end of the quarter in which you were paid for the invoice (and on the other side – when you paid for your purchases)
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Flat Rate Scheme (FRS)
This scheme can save you a lot of money in certain industries. You get given a flat percentage rate dependent on the industry you are in. Let’s assume 11%. You then charge VAT at the usual rate but you only pay over to HMRC 11% of your Gross (meaning inclusive of VAT) turnover. You can’t claim back any VAT on your purchases (With a few exceptions), but you don’t hand over all of the VAT you receive to HMRC.
