Whether you are a small business owner or not, we are all used to seeing (and paying) VAT on the majority of our bills and receipts. VAT or value added tax is a tax based on the value of goods or services. VAT is charged when a VAT registered business sells goods or services to another business, or to a non-business customer. Does your small business need to register for VAT? What are the benefits and downfalls of registration? Can you register even if there is no legal requirement? What can you charge/claim back VAT on? How should you invoice with VAT? These are all questions you should consider when running your small business and here at Atkinson Accounts, these are all frequently asked questions.
What is VAT?
VAT is an acronym for Value Added Tax, although the rates vary between countries, it is commonly understood throughout the EU as a percentage charge paid by the customer when purchasing particular goods and services.
VAT can be shown on top of a price if it’s a business-to-business sale and will be shown within the price if it’s a direct or consumer sale.
For example—a business sells a mobile phone direct to a consumer, the price is £120. If the rate of VAT is 20%, then the VAT included on this transaction will be £20. When a business charges VAT on a sale, they’re collecting that money on behalf of HM Revenue & Customs.
If a business is VAT registered, they can reclaim the VAT they’ve paid on purchases. The difference between what they’ve charged on sales and what they’ve paid on purchases must be sent to HM Revenue & Customs. If this is a negative figure, then it means they’ve more to reclaim then they’ve charged, and HM Revenue & Customs will send the business the amount due.
Any business selling VATable products or services can become VAT registered. However, businesses with a turnover above the VAT threshold will be required by law to register. Once VAT registered, a business will need to charge VAT at the applicable rate on all VATable sales to UK customers.
There are three different rates for VAT, as below:
Standard rated – Since January 2011, the standard VAT rate has been set at 20%. This is the rate that the majority of products and services are.
Reduced rated – The reduced VAT rate is 5% and applies to things such as children’s car seats or light and heat
Zero rated – Zero rated means that the good are still VATable, but the rate of VAT charged is 0%. This type is different to VAT exempt and these transactions should still be recorded in your VAT records and reported on your VAT return.
Do I need to register for VAT? Compulsory registration
A lot of new businesses believe that they must be VAT registered. However, in reality many small businesses are not required to.
HMRC state that a business (either a sole trade or limited company) must register for VAT if one of the following applies:
- If your VAT-able turnover (the total of everything sold that is not VAT exempt) exceeds £85,000 (2018/19) in any rolling 12-month period.
- You expect your VATable turnover to exceed £85,000 in the next 30-day period
It is important to note that if you register late you must still pay the VAT you owe from the point you should have registered.
What are the benefits to VAT registration?
- Reclaiming VAT on purchases – Although you will be required to pay over VAT on all sales once you are registered, this also means you are able to claim back the VAT on any purchases made. If your purchase tax exceeds your sales tax for the period, you can reclaim the difference back from HMRC.
- Better business impression – Registering for VAT can make a business appear larger or more established. A lot of business customers (particularly those working within B2B industries) are aware of the £85,000 threshold. Therefore, if a business is not VAT registered and under the threshold, they may appear less established and this may affect a customer’s decision when purchasing.
What are the negatives associated with VAT registration?
- Charging VAT on sales – Once a business is VAT registered, they must pay over VAT on all of their VATable sales. There are two ways in which a business can choose to deal with this hit, both cause their own disadvantages:
- Higher sales prices – A lot of small businesses registering for VAT will often increase their sales price by adding on the 20%, effectively passing the VAT burden to their customers. Whilst this will not affect any VAT registered customers (as they are able to claim it back from HMRC on their VAT return). It will, however, affect any none registered businesses. For example, if a company is selling desks for £100 before registration, they may decide to increase their sales prices by 20% to £120. They are then charging on the VAT and will still receive the full £100 turnover they would have before registration. This price increase could run the risk of losing either existing or potential customers.
- Reducing net turnover – A business may also choose to take the ‘hit’ of VAT themselves. Businesses often do this when the risk of losing customers due to their sales price increase is too high. The gross price will remain the same, whilst the net the company receives (after VAT) is reduced. For example, if a company is selling computers for £120 and then becomes VAT registered, they may decide to incur the VAT themselves. In this example £20 is paid to HMRC, with the company’s turnover reducing by the same amount.
- Cash flow – No matter how your business chooses to deal with the points above, if your sales tax exceeds your purchase tax, you will be required to pay the difference to HMRC. This is usually done every 3 months, after your quarterly VAT return is filed. This can cause cash flow and financial planning problems for businesses where purchases and sales may vary period to period.
- Increased paperwork – VAT registration also requires businesses to complete additional paperwork. VAT returns are usually filed quarterly, and VAT will have to be considered during your existing bookkeeping and reporting methods.
- Penalties – There are also penalties for late filing and late registration, which add up quite quickly!
How do I register?
VAT registration can be done online for most small businesses. HMRC allows you to appoint an accountant/agent to submit your VAT returns and deal with HMRC on your behalf. At Atkinson Accounts, this is how the majority of our VAT registered clients operate.
We hope that this helped you along with VAT process. If you have any queries with the above or would just like a chat with one of our experienced Chartered Accountants please give our offices a call on 01244 31 6449.