Tax. Three little letters that strike fear in to the hearts of any budding entrepreneur.
The UK has some of the most complex tax laws in the world, so it's important for your future business, and sanity, to have a basic level of understanding for the most common type of business related tax - welcome to VAT (Value Added Tax).
(IMPORTANT: This article is based on generic advice that is freely available online and may not be wholly accurate. We recommend you seek the services of a reputable accountant or tax adviser to gain more accurate detail about your specific tax liabilities and reporting requirements.)
THE DEFINITION OF VAT
VAT or Value Added Tax is a sum charged on the majority of goods and services in the UK. With the exception of things like insurance, postage stamps or certain food and drinks products.
You can read more about VAT exemptions by Clicking Here < this link takes you to the Gov.uk HMRC website.
There are 3 rates of VAT, Standard Rate - 20%, Reduced Rate - 5% and Zero Rate - 0%.
When you buy something from a shop, VAT has already been added on to the total price. So, if you pay £5.99 for something, the shop has included £1.20 in VAT (20%) - unless it's exempt of course!
There's also the issue of Zero Rated and VAT Exempt - they look like the same thing, both ending with a big '0' but Zero Rated means that the goods are still VAT taxable but you don’t charge your customers any VAT.
You must still record these sales in your VAT accounts and report them on your VAT Return, which means you can reclaim VAT on your expenses.
VAT exempt items are outside of all VAT schemes and are not taxable. You don’t include sales of exempt goods or services in your taxable turnover for VAT purposes. If you buy exempt items, there’s also no VAT to reclaim!
In both cases, you don’t add VAT to the selling price, but zero-rated goods or services are taxable for VAT.
WHO CAN REGISTER FOR VAT?
It's important to remember that VAT doesn't just apply to big multi-nationals or established Limited Companies. Individuals and sole traders can be within the scope of VAT limits if they exceed a certain turnover within the preceding 12 months of trading.
It's also misconstrued that you have to wait until you hit one of these upper limits before registering, when in fact, you can voluntarily register from day one of trading, even if you've made no sales. Some businesses prefer to do this, if they're planning to expand rapidly and want to have everything matching up from day dot.
WHEN MUST I OR MY COMPANY REGISTER FOR VAT?
If you haven't registered voluntarily, then you are legally required to register when your total turnover exceeds the threshold of £85,000 within a 12 month (rolling) period.
Or, if you expect your taxable turnover to exceed the threshold within the next 30 days. For example, if you were to sell a large piece of machinery for £90,000, that would put you over the limit straight away!
Or, you only sell goods or services that are VAT exempt - but you also purchase goods to use in your business that have a threshold higher than £85,000 - you must register.
It's also important to allow enough time for registering. It's not instant, even with the way the internet works these days. HMRC have to consider your registration and cross check against any previous applications from yourself or your company.
If you fail to notify HMRC within the correct time-frames, you may be liable for penalties.
WHEN DO I START CHARGING VAT?
If you voluntarily register, then you must start charging VAT on any invoices straight away and recording all VAT on expenses for your business. This way, you can reclaim VAT on your expenses to offset the amount you pay in VAT.
For most eCommerce retailers that deal with standard VAT products e.g. 20%. A typical VAT calculation would look like this:
Your Price: £10.99 inc. VAT
VAT Included: £2.20
Wholesaler Price: £5.99 inc. VAT
VAT Reclaimed: £1.20
Total to Pay HMRC: £1
In the figures given above, you must record both sides of the VAT, so that your bank account makes sense and you can keep track of everything.
You must also start charging VAT if your turnover reaches the VAT limit within any 12 month rolling period. You must start charging VAT from the first day of the second month after you exceed the threshold!
If you expect to exceed the threshold in any single 30 day period, you must start charging VAT immediately on all invoices.
VAT AND RECHARGED EXPENSES
Recharges are essentially costs that your business or you incur when supplying goods to customers.
For VAT registered businesses, you'll need to charge VAT on the amount recharged to the customer, even if the expenses your business incurred and paid for are not subject to VAT.
Plane tickets are not within the scope of VAT. If you pay £500 for your ticket, you include that as an expense in your accounts. However, if you then go and pass that cost on to your client and include it within an invoice, you must add VAT!
WHAT'S THE WORST THAT COULD HAPPEN IF I DON'T REGISTER?
Flying by the seat of your pants is not recommended in any form of business. Failure to register for VAT in the correct time frames could have dire consequences for your business venture!
If you're late registering, then HMRC has the power to retrospectively register your business and start collecting the VAT owed from that date. You'll of needed to add VAT from that date, otherwise HMRC may demand a fair chunk of cash to correct the balance.
On top of having to pay to correct any mistakes, HMRC may issue you with a penalty!
If you voluntarily register for VAT, there are some positives! You can reclaim the VAT on certain expenses for your business. For example, if you purchase office furniture, then you'll pay the full amount up front but you can reclaim up to 20% a few months later. This actually works out as offsetting or reducing your final VAT bill by using VAT inclusive purchases for business purposes.
If you deal with other businesses, it can also be beneficial to be VAT registered. They may be VAT registered themselves, so pricing and profit margins are easier to forecast from day one.
WHY MIGHT VOLUNTARY REGISTRATION BE A BAD IDEA?
If you sell to the general public or very small micro businesses, it's unlikely that they will be VAT registered. So, they are unable to claim back any VAT you charge on top of your invoices. Remember, VAT is a tax, it is not your money. You place the tax on top of any invoices or product prices and the customer pays the full sum. If they're VAT registered, they can claim back at a later date.
MAKING TAX DIGITAL
As of 1st April 2019, if you're trading above the VAT threshold, you must comply with Making Tax Digital for Business regulations. This means keeping an electronic record and submitting digitally using approved software - we recommend Xero - Click Here to visit their website.
You can also read more about Making Tax Digital by Clicking Here.
HOW DO I REGISTER FOR VAT
There are two ways. You can register via the official Gov.uk by Clicking Here.
Or, you can seek the assistance of an accountant to do this for you. You can find an ICAEW approved Chartered Accountant by Clicking Here.
HOW OFTEN DO I NEED TO FILE A VAT RETURN?
You must file a VAT return every 3 months from the date of registration. If you do not, you may incur a penalty from HMRC for late filing.
To submit a VAT return, you must either use the links above to find a suitable accountant or use HMRC approved accountancy software. They won't accept spreadsheets or calculations on pieces of paper. Everything is automated and expensive machines like everything to have a straight edge and neat text, they don't like scribbles and neither do HMRC.
For more information on how to fill out your return and what information is accepted by HMRC, click here.
For VAT registered businesses, a VAT return is required every quarter (3 months). All VAT returns are filed online. Depending on the calculations, you may be required to either pay HMRC for VAT outstanding or you may receive a payment from HMRC, for example, if in your first quarter you've spent a lot on purchasing equipment and office furniture but haven't made that many sales. Your VAT liability is likely to be lower than the amount you're reclaiming, so HMRC will pay the difference back to your account.