vat for contractors

Share This Guide, Choose Your Platform!

Introduction 

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 you should know once your business is VAT registered. What’s more, when you run your own company and register for VAT, it’s helpful to understand 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 VAT rate in the UK is 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 confuse a bright person. This UK contractor VAT guide is written to be VAT explained for dummies or newbies with a focus on the VAT basics explained. As VAT is a contractor’s tax, you must understand how it works once your business registers for VAT.

In this guide, we’ll consider whether businesses pay VAT, how does VAT work and how it affects your business. We’ll look at when 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 businesses and contractors. In addition, we’ll cover limited company contractor VAT and how small businesses and VAT work under the UK VAT system.

Initial thoughts 

How does VAT work for a business, and what is VAT (UK)?

How does business VAT work for UK contracting professionals? In this UK VAT explained guide, we’ll research the VAT process and how limited company VAT works for UK businesses. When working as a contractor (UK), this is something to be aware of, especially if you must 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 want to read HMRC’s VAT rules and procedures guide, please visit their VAT Notice 700. Another helpful page is HMRC’s community forums on VAT-related issues.

It’s key to note that VAT is a tax in the United Kingdom. VAT stands for Value Added Tax. This is a tax on UK business sales, known as the trading tax, and most countries have such a tax. VAT is chargeable by VAT-registered businesses on most goods and services they provide to their customers. A practical VAT guide is this page from Ross Martin, which provides precise details on complicated subjects.

Besides this guide on VAT explained (UK), we’ve written about limited company taxes for ease of reference. VAT is part of your contractor taxation in general, and when you own a business, there are other company taxes to consider. In addition, we have a guide which covers the filing dates for official documents and tax payments.

What is the UK VAT rate?

At present, the standard VAT rate (UK) is 20%. When we consider how does VAT work in the UK and whether companies pay VAT, if you’re a VAT limited company or business, when you create a sales invoice, you’ll likely have to add VAT to your contractor services or sales at 20%.

VAT for IT contractors & the VAT registration processes 

Compulsory registration

A business must register for VAT if:

  • It expects its VAT taxable turnover to be more than £90,000 in the next 30-day period.
  • The business had a VAT-taxable turnover of more than £90,000 over the last 12 months.

When considering contractor VAT, if a business exceeds the VAT threshold of £90,000, it must register for VAT within 30 days. The £90,000 annual threshold is the business’s taxable turnover, the income 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 if you pay VAT on the first £90,000. 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 £90,000 for several years now. Therefore, if you’re near the turnover threshold, you must keep your eye on this. It’d help if you kept an eye on this on an ongoing (annual) basis. 

Voluntary registration

As part of this contractor VAT guide in the UK, it’s essential to note a business can choose to voluntarily register if its taxable business turnover is below £90,000. Many UK contractors decide to register for VAT when they first set up. They’ll do this even if they’re going to be beneath the VAT threshold in the UK. When your company is VAT registered, it can reclaim the VAT on its business expenses.

HMRC VAT guide & what is the VAT registration time frame? 

Today, unlike the old paper forms, you can apply for VAT registration online. When considering UK VAT registration, the online process has a much quicker turnaround time than applying through the post.

As part of the online process, you’ll set up a Business Tax account with HM Revenue & Customs (HMRC). When you do this, you can apply to register for VAT simultaneously. The postal route is still available, but this will take much longer.

Once you submit your UK contractor VAT registration application form online, receiving your VAT registration number will generally take two weeks. However, their online message says it could take up to 40 days. HMRC will post a letter to the company showing the business’s VAT registration date and VAT number. In practice, this usually arrives within 14 days. 

VAT for contractors & what do you do once you register for VAT? 

Initial considerations   

Before 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 it to them for their records.

As mentioned earlier, when you register for VAT, the standard United Kingdom VAT rate will apply to your business if you supply VAT-chargeable services or goods. 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 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 invoice customers who aren’t VAT-registered. When you compare this to your rival businesses, it’ll make you more costly and maybe uncompetitive. As a result, you may have to reduce your charges accordingly to stay competitive.

It’s worth noting that there are other benefits to 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 be a company and VAT registered.

Before you register for VAT, it’s worth chatting with your accountant. They can advise you on what’s best for you. 

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 registration date as the day you start contracting. Alternatively, you could select the date you think you’ll issue your first invoice.

In our guide to VAT, we now look at when you should start charging VAT as a small business. Once registered, you’ll charge 20% VAT on your contractor services on your first invoice after your registration date. On this contractor website, we have a further guide on how to create your contractor invoice. This contains a contractor invoice example. In addition, we’ve another guide which explains the process to follow when recharging expenses.

What should you do when waiting for your VAT registration number?

If you’ve applied to register for VAT, are waiting for your VAT registration number, and want to charge your customer or client, you may ask if I can charge VAT without being registered. The answer here is you can’t charge VAT as you don’t yet have your VAT number. As mentioned above, your VAT number usually takes 14 days to arrive. Therefore, in most cases, you must wait until you receive this before you raise your invoice and charge VAT on your work.

Occasionally, your VAT registration number may not come through within 14 days, and there may be a delay on HMRC’s side. If this happens and you want 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, you should add a `footnote’ to the invoice. This footnote should read, `we will issue a VAT-only invoice in respect of these charges later 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.

With regard to business VAT filing, there’s an 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). What’s more, you have UK costs that include VAT, and hence, you are due regular refunds. You can 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 with HMRC is one month and seven days after the end of the VAT return period. HMRC must also receive the VAT payment within the same timeframe. Therefore, as a UK contractor, if your Ltd company VAT return ends on 31 January, you must ensure 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 businesses, you can also choose to pay your VAT bills by direct debit. If you do, HMRC will 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 digital method of reporting 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 like this is excellent for recording your company’s transactions. Good business records for each accounting period will make it easier for your accountant to prepare year-end annual accounts, which should reflect in your company’s accountancy costs.

Basics of VAT for contractors & the actual VAT return  

Output VAT & Input VAT   

The term we use for VAT on your contractor services or sales is the `output’ tax.

Likewise, we refer to the VAT on your business expenses and costs as the `input’ tax.

Complete the VAT return & VAT return boxes explained 

When we investigate how does VAT work (UK), the VAT return contains nine boxes that you must complete on each VAT return. What’s more, the `normal’ contractor will only have 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 that either:

  • Your business pays to HMRC or
  • HMRC refunds your business. If a VAT refund is due, HMRC will repay this.

When you have a liability, the VAT you pay against it is credited against your liability with HMRC. Likewise, if a refund is due, once HMRC refunds it, it goes against the amount they owe you.

VAT on your costs & expenditure 

Guide to VAT & reclaiming VAT on costs

One of the main plus points of registering for VAT is that you can reclaim VAT on any business purchases that include VAT. In the future, the actual cost of these to your business is the amount before VAT. When you claim back VAT, you must obtain any invoices or receipts relating to the expense (and VAT) your business claims. Therefore, your business can reclaim any VAT your suppliers charge you. Alternatively, there’ll be no VAT to reclaim when paying someone who is not VAT registered.

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 & which types of costs 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 -taxable through the insurance industry.
  • Flights -taxable through the aviation industry.
  • Rail fares.
  • Postages.
  • Bank charges.
  • 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, including home energy and children’s car seats, have a reduced UK VAT rate. During the recent pandemic, the hospitality sector also received a reduced rate of VAT, which ended on 31 March 2022.

VAT on digital products & services

When considering VAT, your company could supply 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 & what is the reverse charge procedure?

This seems like a complex solution to a straightforward issue regarding how VAT works for foreign transactions. However, it applies when you buy services from outside the UK. The reverse charge on services 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.
  • Certain other services.

When you deal with the reverse charge, you’ll calculate the VAT amount (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 the VAT on purchasing these supplies, you’ll put the same figure in box 4 (this, in effect, cancels out the figure in box 1).
  • The full value of the supply is in boxes 6 (sales) and 7 (costs).

This UK VAT guide from HMRC covers VAT on imports, acquisitions, and services from abroad in more detail.

Guide to VAT & what are the types of VAT schemes (UK)? 

Several VAT schemes are available when registering 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.

minus

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 this, it’s important to highlight that the 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, many fewer contractors use the FRS scheme, and 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. 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 contracting VAT guide, it’s key to note that if you don’t qualify under the new rules, the change, in effect, is 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, you’ll save only 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 is part of our handy tax tips for contractors and small business owners.

Penalties 

What happens if you miss a VAT return deadline?

There are penalties for not registering or late registration. Fines and interest are also charged for paying VAT bills late, which can add up. Therefore, you must ensure you and your accountant keep up with 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 stating 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 from 1 January 2023.

VAT return penalties

Under the new rules, you’ll receive a penalty point for each return you submit late to HMRC. 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 at the penalty point threshold. Therefore, if you’ve reached the threshold for late submission penalty points, you should 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 you must satisfy before HMRC removes them. You can find out more about how to remove penalty points here.

VAT payment interest

Any VAT periods that start on or after 1 January 2023 are subject to interest if you make a late payment. Therefore, if you pay VAT-related amounts late, HMRC will ask you to pay late payment interest on the amount outstanding. This applies from the first day your payment is overdue to the day you pay it in full.

Avoid VAT penalties

When you report and pay HMRC VAT, it’s clearly in your best interest to avoid penalties. Moreover, if you’re consistently late, HMRC will scrutinise you more closely and may take a closer look into your affairs. Therefore, you should ensure you or your accountant process 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).

What are any other considerations? 

VAT for contractors & how do you correct 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 exceeds £10,000, you must report this to HMRC via form VAT652.

VAT for contractors & the benefits of being registered

As mentioned in this VAT guide in the UK, customers and clients who are VAT registered can reclaim the VAT you charge 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, knowing that it is VAT registered and can reclaim their input VAT, too.

Your accountant will typically handle VAT registration for your UK business. This is one of the first tasks they’ll carry out when you set up a new company.

Further thoughts on VAT for contractors

This VAT guide for small businesses and contractors should give you insights into how VAT works. When it comes to VAT, the best advice for contractors is to appoint an accountant to help guide them. Your accountant can advise you which VAT scheme is most suitable 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 is usually unlikely. We recommend using the Cash Accounting choice.

How can your business de-register for VAT?

If your business turnover falls beneath the VAT de-registration threshold of £88,000, 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. It’ll depend on your individual circumstances.

When your business finishes trading, it has to de-register for VAT, and 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 log in and access your VAT service. Once you select this option, you can follow the procedure online. Basically, you must choose a date for your de-registration, and there are several questions to answer before you can submit the application. Alternatively, you can complete VAT form 7 and send it through the post to HMRC.

As part of de-registering, you may have to complete a final VAT return form up to the date your business de-registers. Once you apply, HMRC will write to you to confirm the business is de-registering, and 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’ve done this, there should be nothing more to do regarding VAT.

Furthermore, if you incur any VAT after VAT deregistration that you have not claimed via a previous VAT return, you can claim this back via form VAT427.

Final thoughts 

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 there are many VAT rules to bear in mind, which cover all sorts of areas concerning the UK VAT system. Basically, VAT is one of your main contractor taxes, and you can easily get lost if you’re unsure. 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

LinkedIn    https://www.linkedin.com/groups/4660081/

Published On: April 6th, 2024 / Categories: Company Taxes, Guides, Tax Guides /

Share This Guide, Choose Your Platform!

Leave A Comment