Introduction -UK VAT guide for contractors and small business
This HMRC VAT guide (United Kingdom) is a handy reference point as it covers VAT for contractors and small businesses in the UK. Our UK VAT guide explains how VAT works when you’re IT contracting (UK) or contracting in another industry. This in-depth IT contractor VAT guide is a dummies guide to VAT in the UK. We explain many aspects which you should be aware of, once your business is VAT registered. What’s more, when you run your own company and you register for VAT, it’s helpful to know how does VAT work for small businesses. As the owner of a UK contractor limited company, once you’re registered, VAT is one of your main contractor taxes and the current rate of VAT in UK is currently 20%. Therefore, in this guide, we’ll investigate how does VAT work for a limited company.
VAT can be pretty complex for laypeople, and the technical bits from HMRC VAT guidance can even confuse a bright person. This UK contractor VAT guide, is written with an aim to be VAT explained for dummies or newbies with a focus on the VAT basics explained. As VAT is a contractor’s tax, it’s important that you understand how this works once your business registers for VAT.
In this guide, we’ll consider do businesses pay VAT, how does VAT work and how does it affect your business. What’s more, we’ll also look at when do I need to charge VAT, do contractors charge VAT and do contractors pay VAT. Furthermore, in this easy-to-follow UK VAT guide we’ll cover basic VAT accounting for small business and contractors. In addition, we’ll cover limited company contractor VAT and how small business and VAT works under the UK VAT system.
VAT for contractors -how does VAT work for a business and what is VAT (UK)?
How does business VAT work in practice for UK contracting professionals? In this UK VAT explained guide, we’ll research the VAT process and how limited company VAT works for UK business. When you’re working as a contractor (UK) this is something to be aware of, especially if you need to register. Most IT contractor companies and other UK contractors are required to register, due to their level of turnover. Therefore, in this UK business VAT for dummies guide we’ll research VAT for self-employed contractors and what to consider when you’re VAT registered. If you’d like to read HMRC’s guide to VAT rules and procedures, please visit their VAT Notice 700. What’s more, another helpful page is HMRC’s community forums on VAT related issues.
It’s key to note, VAT is a tax in the United Kingdom and VAT stands for Value Added Tax. This is a tax on UK business sales, and it’s known as the trading tax, and most countries have such a tax. VAT is chargeable by VAT-registered businesses on most goods and services which they provide to their customers.
Besides this guide on VAT explained (UK), for ease of reference, we’ve have written about limited company taxes. VAT is part of your contractor taxation in general and when you’ve your own business there’s other company taxes to consider. In addition, we’ve a guide which covers the filing dates for official documents and tax payments.
The UK VAT rate
At present, the standard VAT rate (UK) is 20%. When we consider how does VAT work in UK and do companies pay VAT, if you’re a VAT limited company or business, when you create a sales invoice, you’ll likely need to add VAT to your contractor services or sales at 20%.
As a UK business owner, when you’re new to VAT you’ll likely have many questions how it works. Such thoughts and questions could include:
- What is VAT threshold (UK)?
- Is the VAT threshold gross or net?
- Can you charge VAT if not VAT registered?
- Does a limited company need to be VAT registered?
- How does VAT affect a business?
- Do I need to pay VAT as a small business?
- Do limited companies pay VAT?
- How does VAT work in the UK?
- Is it worth being VAT registered?
- When do you start paying VAT?
- Charging VAT on services (UK).
- Do I charge VAT for services to overseas clients?
Therefore, in this guide we’ll consider all the above and look at when do businesses pay VAT and what is VAT and how does it work. Another useful VAT guide is this page from Ross Martin who provide very clear detail on complicated subjects.
VAT for contractors -the VAT registration processes
A business must register for VAT if:
- It expects its VAT taxable turnover to be more than £85,000 in the next 30-day period.
- The business had a VAT-taxable turnover of more than £85,000 over the last 12 months.
When we consider contractor VAT, if a business exceeds the VAT threshold of £85,000, it must register for VAT within 30 days. Basically, the £85,000 annual threshold is the business’ taxable turnover and this is the income which is subject to VAT. However, certain services and goods and services to foreign B2B customers aren’t subject to UK VAT.
Some business owners may ask do you pay VAT on the first £85,000. However, once you’re VAT registered, you’ll charge VAT on all your vatable services. Then, you’ll pay your VAT bill to HMRC after you deduct any VAT on costs (see later).
The VAT registration threshold usually increases slightly in most years. However, it hasn’t increased from £85,000 for several years now. Therefore, if you’re near the turnover threshold, you need to keep your eye on this. Basically, it’d help if you keep your eye on this on an ongoing (annual) basis.
As part of this contractor VAT guide in the UK, it’s essential to note that a business can choose to voluntarily register if its taxable business turnover is below £85,000. Many UK contractors decide to register for VAT when they first set up. They’ll do this even if they are or will be beneath the VAT threshold in UK. When a business is VAT registered, it can reclaim the VAT on its business expenses.
HMRC VAT guide -the VAT registration time frame and the VAT application process
Today, you can apply for VAT registration online, unlike the old paper forms in the past. When we consider UK VAT registration, the online process has a much quicker turnaround time when comparing this to applying through the post.
As part of the online process, you’ll set up a Business Taxes account with HM Revenue & Customs (HMRC). When you do this, you can apply to register for VAT simultaneously. However, the postal route is still available, but this’ll take much longer.
Once you submit your UK contractor VAT registration application form online, it’ll generally take two weeks days to receive your VAT registration number. Their online message says it could take up to 40 days to receive this. Basically, HMRC post a letter to the business showing the VAT registration date and VAT number. In practice, this usually arrives within 14 days.
VAT for contractors -what to do once you register for VAT
Before you start contracting for your client, they may request to see your VAT certificate as a VAT-registered business. Once you have the certificate, you can send this onto them for their records.
As we mention earlier, when you register for VAT, if you’re supplying VAT-chargeable services or goods, the standard United Kingdom VAT rate will apply to your business. Therefore, you’ll charge your customer or client and issue VAT invoices. When you do this, you’ll add VAT to your services at 20%.
UK VAT guide -further considerations
As part of this HMRC VAT guide in the UK, it’s important to note that if your customers are VAT registered, they can reclaim the VAT you charge them. If you send invoices to customers who aren’t VAT registered, such as individuals, your VAT charge is an extra cost to them, on top of the charge for your services. Therefore, this is something to bear in mind if you’ll invoice customers who aren’t VAT-registered. It’ll make you more costly, and you may be uncompetitive when you compare this to your rival businesses. As a result, you may need to reduce your charges accordingly to stay competitive.
It’s also worth noting that there’s other benefits of being VAT registered. As a VAT limited company contractor in the UK, the business world will see your company as more `official,’. Indeed, it’ll give you more credibility than not being VAT registered. When quoting for work, some companies mandate that suppliers must be a company and be VAT registered.
Before you register for VAT, it’s worth a chat with your accountant. Basically, they can advise you on what’s best in your circumstances.
VAT explained for small businesses -our guide to VAT
Charging VAT as a small business
The date you first register for VAT with HMRC is your `registration date.’ Your choice of registration date is the day you must start charging VAT on your goods or services. When registering for VAT, you could choose your date of registration as the day you start contracting. Alternatively, you could choose the date when you think your first invoice will be.
In our guide to VAT, we now look at when you first need to start charging VAT as a small business. Once registered, on your first invoice after registration date, you’ll charge VAT at 20% on your contractor services. On this website we’ve a further guide on how to create your contractor invoice. This also contains a contractor invoice example. In addition, we’ve another guide which explains the process to follow when recharging expenses.
Waiting for VAT registration number
If you’ve applied to register for VAT, are waiting for your VAT registration number, and need to charge your customer or client, you may ask can I charge VAT without being registered? The answer here is you can’t charge VAT as you don’t yet have your VAT number. As we mention above, it usually takes 14 days for your VAT number to come through. Therefore, in most cases, you’ll need to wait until you receive this before you raise your invoice and charge VAT on your work.
On some occasions, your VAT registration number may not come through within 14 days and there’s a delay on HMRC’s side. If this happens and you need to raise an invoice, you can go ahead and do this. The invoice will show your charges or sales, but you can’t add VAT yet. Instead, and you should add a `footnote’ to the invoice. This footnote should read, `we will issue a VAT-only invoice in respect of these charges at a later date once we receive our VAT registration details.’ Then, in due course, once you receive your VAT number, you can raise a VAT-only invoice. On this VAT only invoice you can cross-refer to the original invoice(s) where you didn’t charge VAT.
Once you register for VAT, you must include your VAT registration number on all your invoices to your customers and clients.
Basics of VAT -the HMRC VAT return period
In this contractor VAT guide in the UK, we now look at what VAT periods (UK) contractor small business VAT returns cover. Unless you plan to report on the Annual VAT Scheme, VAT returns will cover three-month periods. Therefore, dependent on when HMRC sets your first VAT return, your small business VAT returns could end on:
- 31 January, 30 April, 31 July, and 31 October.
- 28 February, 31 May, 31 August, and 30 November.
- 31 March, 30 June, 30 September, and 31 December.
As we look at VAT for self employed contractors, there’s also the option to file monthly VAT returns. Indeed, you may opt for this if you’ll be due regular refunds from HMRC. This could occur if most of your customers are abroad (sales abroad don’t usually attract UK VAT). Also, you have UK costs that include VAT and hence, you are due regular refunds. You could also file VAT annually; however, many UK contractors or businesses don’t opt for this.
When you file your future VAT returns, the due date for filing the VAT return with HMRC is one month and seven days after the end of the VAT return period. HMRC also needs to receive the VAT payment within the same timeframe. Therefore, as a UK contractor, if your ltd company VAT return ended on 31 January, you’d need to ensure that HMRC receive the VAT return and the payment in respect of this (if a payment is due) by 7 March.
When it comes to paying VAT for small business, you can also choose to pay your VAT bills by direct debit. If you do, HMRC give you an extra three days before they take this. In the above example, when paying VAT as a business, they’d take the direct debit on or around 10 March.
VAT for contractors -Making Tax Digital (MTD)
As part of this UK VAT guide, it’s now essential to highlight the recent introduction of Making Tax Digital (MDT). This is a method of digital reporting of your VAT return figures to HMRC. Today, all VAT-registered businesses must submit their VAT returns via MTD online accounting-compliant software.
Popular accounting software choices for businesses include FreeAgent, Xero, and others. Indeed, FreeAgent is the most popular choice for UK contractors. An accounting system such as this is a good choice to use for recording your company’s transactions. When you’ve good business records for each of your accounting periods, it’ll make things easier for your accountant in terms of preparing year-end annual accounts. In turn, this should reflect on what your accountancy costs your company pays.
Basics of VAT for contractors -the actual VAT return
Output VAT and Input VAT
The term we use for VAT on your contractor services or sales is the `output’ tax.
Likewise, the term we use for the VAT on your business expenses and costs is the `input’ tax.
Complete the VAT return and VAT return boxes explained
When we investigate how does VAT work (UK), the VAT return contains nine boxes which you need to complete on each VAT return. What’s more, the `normal’ contractor will only need to complete the following boxes:
1 The VAT on sales –output tax.
4 The VAT on business purchases and expenses –input tax.
6 Net sales -outputs.
7 Net purchases and expenses -inputs.
Box 5 is, in effect the sum of box 1 less box 4.
Therefore, box 5 is the amount you need to either:
- HMRC needs to refund your business. If a VAT refund is due, HMRC will repay this.
When you have a liability, the VAT you’ve paid will be credited against your liability with HMRC. Likewise, if a refund is due, once HMRC refund this it’ll go against the amount that they owe you.
VAT on your costs and expenditure
Guide to VAT -reclaim VAT
One of the main plus points when registering for VAT is you can reclaim the VAT on any business purchases that include VAT. Basically, in the future, the actual cost of these to your business will be the amount before VAT. When you claim back VAT, you’ll need to obtain and retain any invoices or receipts that relate to the expense (and VAT) which your business is claiming. Therefore, your business can reclaim any VAT your suppliers charge you. Alternatively, when you’re paying someone who is not VAT registered there’ll be no VAT to reclaim.
If you usually pay VAT to HMRC, there may be times or instances when the VAT on purchases and expenses exceed the VAT on your sales in a given VAT quarter. In this case, HMRC will refund the difference to the business.
VAT for contractors -the types of costs which don’t include VAT
When we investigate how VAT works, do bank charges have VAT? Furthermore, do rail fares have VAT? Basically, certain services and goods are exempt supplies and fall outside the UK VAT system. Such goods and services which are exempt from VAT include:
- Insurance -this is taxable through the insurance industry.
- Flights -these are taxable through the aviation industry.
- Certain educational training and teaching costs.
- Books, booklets, brochures, pamphlets, and leaflets.
- Newspapers, journals, and periodicals.
- Most food from shops and supermarkets (not restaurants).
- Many other items which HMRC regard as `essentials’.
Some goods and services also have a reduced UK VAT rate, including home energy and children’s car seats. During the recent pandemic, there was also a reduced rate of VAT given to the hospitality sector. This ended on 31 March 2022.
VAT on digital products and services
As we consider VAT for contractors, it could be the case that your company supplies digital products or services to a client in an EU country. In this case, the VAT to charge is based on the customer’s country’s VAT rate. Your business must register for the VAT Moss scheme and submit Moss returns in the future.
Guide to VAT -the reverse charge procedure
This seems like a complex solution to a straightforward issue with regard to how VAT works for foreign transactions. However, it applies when you buy services from outside the UK. The reverse charge on services that you purchase only applies when a) the supplier is in a different country from you, b) you are in business, c) you belong in the UK and d) you receive either pay for:
- One of the services covered by the general rule for place of supply of services.
When you deal with the reverse charge, you’ll calculate the amount of VAT (output tax) on the total value of the services supplied to you. On your company’s VAT return, you’ll enter:
- The amount of VAT you calculate in box 1.
- If you’re entitled to reclaim some or all of the VAT on your purchase of these supplies, you’ll also put the same figure in box 4 (this, in effect, cancels out the figure in box 1).
- The supply’s full value in box 6 and box 7.
This UK VAT guide from HMRC covers in more detail VAT on imports, acquisitions, and services from abroad.
Guide to VAT -types of VAT schemes (UK)
There are several different VAT schemes available when you register for VAT as a UK contracting professional. This contractor VAT guide in the UK now investigates what HMRC offers to suit different businesses.
Standard VAT Scheme
Under this scheme, the VAT paid to HMRC is based on:
The total amount of VAT you charge on invoices which you raise during the VAT period.
Any VAT you incur on purchases and expenses by your business during the period.
Cash Accounting scheme
This scheme is the same as the above, except you only pay VAT to HMRC once you receive the funds from your customers and clients. Similarly, you can only reclaim VAT on purchases and expenses once you pay the supplier. As we consider, VAT for contractors it’s important to highlight that this scheme is useful for cash flow purposes. Most owners of a contractor limited company who register for VAT, operate under the cash accounting scheme. The alternative to this is an `invoice scheme’ where you pay over and reclaim VAT once you issue the invoices. Basically, this scheme applies to larger businesses.
VAT for contractors -the Flat Rate VAT scheme
The VAT Flat Rate scheme is a sub-scheme that many limited company contractors would’ve often used in the past.
Today, much less contractors use the FRS scheme as it’s no longer as beneficial as it used to be. HMRC initially brought this scheme out to make accounting easier. Under this scheme, you’d still invoice clients at the standard rate, but you’d pay HMRC a fixed percentage rate of your gross quarterly turnover, depending on the industry in which you operate in. For IT contractors, the rate was 14.5%, and in the first year of operation, the contractor could benefit from a 1% reduction to the fixed rate.
However, in April 2017, the new ‘limited cost trader’ rules came in. HMRC removed most of the benefits of using the VAT Flat Rate VAT scheme for most small businesses, particularly those with low quarterly costs. Therefore, in this VAT for contractors guide its key to note that if you don’t qualify under the new rules, the change, in effect, is that you instead pay over 16.5% of the gross amount invoiced.
This change was sneaky, as 16.5% of the gross invoice is the same as 19.8% of the net invoice. The standard UK VAT rate is 20%. Therefore, now you’ll only save 0.2% of the VAT you charge under this scheme. On a £10,000 + VAT invoice, the saving will only be £20. Thus, operating under the Standard VAT Scheme and Cash Accounting scheme are part of our handy tax tips for contractors and small business owners.
Why you may miss a VAT return deadline
There are penalties for no VAT registration or late VAT registration. There are also fines for the late payment of VAT bills which can add up. Therefore, it’s key you make sure you and your accountant keep on top of your company’s tax and VAT accounting.
For various reasons, a contractor may miss a UK VAT filing deadline. If this occurs, the business will receive a letter from HMRC. It’ll state that HMRC will place the company on a penalty point system for the next twelve months.
Introduction to VAT penalties
The VAT penalty system for late VAT returns and payments was overhauled at the start of 2023. Therefore, from 1 January 2023, you’ll receive penalty points if you submit a VAT return late. This includes any nil payment returns. HMRC will also charge interest on a late HMRC VAT payment too from 1 January 2023.
VAT return penalties
Under the new rules, for each return you submit late to HMRC, you’ll receive a penalty point. When you reach the penalty point threshold, you’ll incur a £200 penalty. You’ll also incur a further £200 penalty for each subsequent late return while you’re at the penalty point threshold. Therefore, if you have reached the threshold for late submission penalty points, you’ll need to take action to get these removed to avoid further £200 penalties. If you’ve not reached the threshold, penalty points will expire after a certain period. However, if you’ve reached the threshold, HMRC has two conditions which you need to satisfy before HMRC to removes these. You can find out more here on how to remove penalty points.
VAT payment interest
Any VAT periods which start on or after 1 January 2023, are subject to interest if you make late payment. Therefore, if you pay VAT-related amounts late, HMRC will ask you to pay late payment interest on the amount outstanding. This’ll apply from the first day your payment is overdue up to the day you pay it in full.
Avoid the penalties
When you’re reporting and paying HMRC VAT, it’s clearly in your best interest to avoid penalties. What’s more, if you’re consistently late, it’ll result in increased scrutiny from HMRC, and they may take a closer look into your affairs. Therefore, you should ensure you or your accountant are processing your VAT returns on time. You could also set up a direct debit, so you’ll never miss a payment (but this relies on the return being filed first).
VAT for contractors -correction of VAT errors
If you discover an error after you submit a VAT return the options are:
- If the error is under £10,000, you can correct this via your next VAT return.
- If the error is over £10,000, you’ll need to report this to HMRC via form VAT652.
VAT for contractors -other thoughts
As we mention earlier in this VAT guide in the UK, customers and clients that are VAT registered can reclaim the VAT you charge to them. This isn’t necessarily an advantage for you however, being VAT-registered can help create a more professional image for your business. As a result, the customer may be more inclined to use your business again soon, with knowledge that your business is VAT registered and they can reclaim their input VAT too.
Your accountant will typically take care of your UK contractor VAT registration for you. This is one of the first tasks they’ll carry out when you set up a new company.
VAT for contractors -further thoughts
This VAT for small businesses and contractors guide should give you a good insight into how VAT works. When it comes to VAT, contractor best advice is to appoint an accountant to help guide you. As a result, your accountant can advise you which VAT scheme is most suited for you.
Today it’s better for contractors to operate under the Standard VAT Scheme, rather than the VAT Flat Rate scheme. That’s unless they qualify as a limited-cost trader under the Flat Rate Scheme, which in most cases is unlikely. We also recommend using the Cash Accounting choice.
If your business turnover falls beneath the VAT de-registration threshold of £83K, you can apply to de-register for VAT. However, many businesses may choose to stay within VAT as they can recover VAT on their costs. Basically, it’ll depend on your individual circumstances.
When your business finishes trading and it needs to de-register for VAT, it can do this through the VAT service in your HMRC Business Tax account. There’s an option to de-register within the main options on the screen after you login and access your VAT service. Once you select this option you can follow the procedure online. Basically, you’ll need to pick a date for your de-registration and there’s also several questions to answer before you can submit the application. Alternatively, you can complete VAT form 7 and send this through the post to HMRC.
As part of de-registering, you may also need to complete a final VAT return form up to the date that your business de-registers. Once the you submit application, HMRC will write to you to confirm the business is de-registering. In addition, they’ll let you know if there’s a final VAT return form to complete. You can file the final return via your online software and, once you have done this, there should be nothing more to do on VAT.
Furthermore, if you incur any VAT after VAT deregistration which you have not claimed via a previous VAT return, you can claim this back via form VAT427.
As you can see from this HMRC VAT guide and when we look at how VAT works, it can be a very complex area for UK contracting professionals. In this VAT for contractors’ guide, it’s key to note that there’s many VAT rules to bear in mind which cover all sorts of areas in respect of the UK VAT system. Basically, VAT is one of your main contractor taxes and you can easily get lost if you’re not sure. Therefore, we hope this UK VAT guide for contractors and small businesses has given good insight, but if you have any questions, you should check these out with your accountant.
Link to Contractor Advice UK group on