In the UK there are businesses of all shapes and sizes. Most start out small, and grow into bigger businesses, some managing to turn themselves into international business powerhouses. But as those businesses grow, they will reach a point where they will need to become VAT registered. VAT registration is mandatory in the UK for businesses that meet certain criteria, though plenty choose to pay VAT even if they don’t have to. Since I know VAT inside out, today I’m going to explain what VAT is, why you need to pay it, and when you need to register.
What is VAT?
The first thing most people ask is ‘what is VAT anyway?’ VAT stands for Value Added Tax, and is a consumption tax assessed on the value added to goods and services, and sits at around 20%, depending on what scheme you’re on. It applies to any purchase of goods or services and other taxable supplies. For businesses, VAT plays an important role. You can both charge VAT on your goods and services, and reclaim the VAT you pay on goods and services too. For most businesses, the areas affected by VAT are:
- Sales of your goods and/or services
- The hire or loan for your goods
- Commission
- Exchanges (e.g. swapping a new product for a customer’s old one)
- Staff sales (e.g. staff meals)
- Business goods you use personally
- The sale of business assets
A common misconception about VAT is that it’s a tax paid by individual businesses. But actually, the ultimate cost is paid by the consumer. While businesses pay VAT to HMRC, the actual cost has already been paid by the customer, covered by the purchase price of the goods or services. As a business charging it, you need to make sure you are reporting it fully to HMRC and paying it. The most important thing to remember is that it is NOT your money, you are collecting it and paying it on to HMRC so please don’t spend it. I recommend that my clients set up a VAT pot with their bank and transfer money into it ready to pay the bill.
Are There Different VAT Schemes?
There are a few different types of VAT scheme available for businesses, each with its own advantages and disadvantages. To know which one is right for your business, you will need to talk to your bookkeeper, or get in touch with us for advice. But we can tell you what each of the schemes look like:
- Standard rate: The most common method used. In this model, businesses need to keep a detailed VAT record of all purchases and sales, and use that to complete a quarterly return with HMRC.
- Annual accounting: Similar to the standard accounting method, but instead of quarterly returns, businesses fill them in annually. This means a higher bulk payment, instead of spreading it over the 4 quarters.
- Flat rate: Mainly for product-based businesses. In this model, the business pays a percentage of their total turnover as VAT. You can only use this scheme if you’re a small business with an annual taxable turnover of £150,000 or less, excluding VAT.
- Cash accounting: In this model, your businesses accounts for VAT on the date you’re paid, instead of the date you send the invoice. This is especially useful if you have slow paying clients, but isn’t great if you buy a lot of items on credit or finance, since you can’t reclaim that VAT until your payment is complete, which could be years down the line.
- Retail VAT: If you’re a retail business, or you’re selling second-hand goods, then there are two extra schemes you might be able to use.
- VAT margin scheme: Where you pay VAT on the value you add to the goods you sell, rather than on the full selling price of each item.
- VAT retail scheme: Calculate the VAT once with each VAT return, rather than calculating it for each sale you make.
When Should I Register?
By law, you have to register for VAT when your annual turnover within a 12-month rolling period reaches the VAT threshold. At the time of writing the threshold sits at £90,000 which changed in April 2024 from £85000 but was frozen for seven years prior to that (though it’s slightly lower if you’re selling goods from Northern Ireland to customers in the EU). It could all change again in the next budget.
That’s why you need to pay close attention to your income, as failing to pay VAT over this threshold can get you some pretty hefty fines. Many businesses opt to register for VAT at the point when they are close to the threshold, allowing them to make the most of their profits before they have to start paying a share to the government. However, some businesses will register voluntarily, sometimes from day one of trading. This is because they will be able to reclaim VAT on their costs, which helps with cash flow, especially in the early days of business. Some others register because it makes them look like a bigger, more established business, while others will intentionally keep their annual turnover below the threshold to avoid registration. It is also worth noting that on the very first VAT Return businesses can go back and claim VAT on purchases they have made prior to registration. As long as assets or stock are still in the business at the date of registration claims can be made for historical purchases for 4 years on products e.g. office equipment and 6 months on services such as rent or software.
What About Making Tax Digital?
I couldn’t write this blog without mentioning Making Tax Digital. MTD has been mandatory for VAT purposes for all VAT registered businesses (regardless of turnover) since April 2022, and HMRC now automatically signs you up to MTD when you register for VAT. So, you’ll need to make sure the way you manage your VAT is compliant from day 1. That means keeping digital records on MTD compatible software, and submitting your VAT returns through that software. You’ll then need to submit a VAT return to HMRC every 3 months, and pay what you owe for that period. You can find out more at MTD by clicking the link above, or buy my guide here. If you’re looking at registering for VAT, struggling to keep up with the returns or just want to know more about MTD, I’d love to help. All you need to do is get in touch with me, and we’ll have a free, no-obligation chat.