VAT guide For UK small business

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Introduction -UK VAT guide for contractors

This HMRC VAT guide (United Kingdom) is a handy reference point as it covers VAT for contractors and small businesses in the UK. It will explain how VAT works and is a detailed in-depth IT contractor VAT guide. In addition, we will cover in this dummies guide to VAT many aspects that you may need to consider when your business is VAT registered.

When you rung your own company and are VAT registered, it is helpful to know how does VAT work for small businesses. As a contractor with your own company, when you are registered, VAT is one of your main contractor taxes. Therefore, we will investigate how does VAT work for a limited company.

VAT can be pretty complex for laypeople, and the technical bits can confuse a bright person. Therefore, we have created an easy-to-follow UK VAT guide that covers the basics of small business and contractor VAT and how this all works under the UK VAT system.

For ease of reference, we also have written about limited company taxes. In addition, we also have a guide that covers the filing dates for official documents and tax payments. 

VAT for contractors -how does VAT work for a business and what is VAT?

How does business VAT work in practice? In this dummies guide to VAT, it is key to note, VAT is a tax in the United Kingdom, and it stands for Value Added Tax. This is a tax on UK business sales and it is 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.

At present, the standard VAT rate in the UK is 20%.

If you are a VAT-registered business, when you create a sales invoice, you will likely need to add VAT to your services or sales at 20%. 

VAT for contractors -the VAT registration processes 

Compulsory registration

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. The £85,000 annual threshold is the business’ taxable turnover. This is the income that is subject to VAT. Please note that certain services and goods and services to foreign B2B customers are not subject to UK VAT.

The VAT registration threshold usually increases slightly in most years. Therefore, if you are near the turnover threshold, you need to keep your eye on this. Notably, it would help if you keep your eye on this on an ongoing (annual) basis. 

Voluntary registration

As part of this VAT guide in the UK, it is essential to note that a business can choose to register voluntarily if its taxable business turnover is below £85,000.

Many contractors decide to register for VAT when they first set up. They will do this even if they are or will be beneath the VAT threshold.

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. Notably, the online registration process now has a much quicker turnaround time, compared to applying through the post.

As part of the online process, you will set up a Business Taxes account with HM Revenue & Customs (HMRC) and apply to register for VAT simultaneously. Please note that the postal route is still available but will take much longer.

Once you submit the contractor VAT registration application form online, it will generally take two working days to receive your VAT registration number. When your VAT number comes through in a message from HMRC, you must wait another two working days. After this, you will have full access to the VAT service on your HMRC Business Taxes account. As part of this, you can download your VAT certificate. However, in more recent times it seems HMRC are now posting out VAT registration numbers for new registrations and their online message says it could take up to 30 days to receive this. In practice this does seem to come through within 10 to 14 days. 

VAT for contractors -what to do when you are VAT registered 

Initial considerations

Clients may request to see your VAT certificate as a VAT-registered business.

As mentioned, when you register for VAT, if you are supplying VAT-chargeable services or goods, the standard rate of VAT applies to your business. Therefore, you will charge your customer or client and issue VAT invoices by adding to your services VAT at 20%. 

UK VAT guide -further considerations

As part of this HMRC VAT guide in the UK, please note that if your customers are VAT registered, they can reclaim the VAT you charge them. If you send invoices to your customers who are not VAT registered, such as individuals, your VAT charge will be an extra cost to them on top of your services. Therefore, this is something to bear in mind if you are invoicing customers who are not VAT-registered. It will make you more costly, and you may be uncompetitive compared to your rival businesses. As a result, you may then need to reduce your charges accordingly to stay competitive.

It is also worth noting that there are other benefits of being VAT registered. As a contractor, the business world can see this as being more `official,’. Notably, it gives more credibility to you than not being VAT registered. When quoting for work, some companies mandate that suppliers must be a company and be VAT registered.

Before registering for VAT, it is worth chatting with your accountant. They can advise you on what is best in your circumstances. 

Guide to VAT-charging and reporting VAT 

Charging VAT as a small business

In this guide to VAT, we now look at when you first need to start 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 want to start charging VAT on your goods or services. When we consider this, you could choose either the day you start contracting or the date of your expected first invoice as your VAT registration date.

If you have applied to register for VAT, are waiting for your VAT number, and need to charge your customer or client, you may ask can I charge VAT without being registered? The answer is no as you cannot charge VAT as you do not yet have your VAT number. As mentioned above, it usually takes two days for your VAT number to come through but can take longer now. Therefore, in most cases, you will be able to wait until you receive this before you raise your invoice and charge VAT on your work.

What to do if you are waiting for your VAT number?

On some occasions, your VAT number does not come through in two days, and there is 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 cannot add VAT yet, instead and you need to 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 cross-referring to the original invoice(s) where you did not charge VAT.

Once you are VAT registered, you must include your VAT number on all your invoices to your customers and clients. 

Basics of VAT -the VAT return period

This VAT guide in the UK now looks at what periods small business VAT returns cover. Unless reporting on the Annual VAT Scheme, VAT returns cover three-month periods. Therefore, depending 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.

There is also the option to file monthly VAT returns, and you may opt for this if you will be due refunds from HMRC regularly. This could occur if most of your customers are abroad (sales abroad do not usually attract VAT), yet you have lots of UK costs that include VAT, and hence you are due regular refunds.

VAT returns need to be filed with HMRC within one month and seven days of the end of the VAT return period. HMRC also needs to receive the VAT payments within the same time frame.

Therefore, as a UK contractor, if your ltd company VAT return ended on 31 January, you would need to ensure that HMRC will receive the VAT return and the payment in respect of this (if a payment is due) by 7 March.

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, they would take the direct debit on or around 10 March. 

VAT for contractors -Making Tax Digital (MTD)

As part of this UK VAT guide, it is now essential to highlight the recent introduction of Making Tax Digital (MDT).

This is the 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.

Basics of VAT -the actual VAT return 

Output VAT and Input VAT

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

Likewise, the term we use for the VAT on your business expenses and costs is the `input’ tax.

Completing the VAT return

The VAT return contains nine boxes that 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, box 1 less box 4.

Therefore, box 5 is the amount that you need to either:

  • Pay to HMRC or
  • 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 will go against the amount that they owe you. 

Guide to VAT -reclaim VAT

One of the main plus points of registering for VAT (if you are charging VAT-registered customers) is that you can reclaim the VAT on any business purchases that include VAT. Therefore, in the future, the actual cost of these to your business will be the amount before VAT. When you claim back VAT, you will need to obtain and retain any invoices or receipts related to the amount of VAT your business is claiming.

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.

The types of costs that do not include VAT

Do bank charges have VAT? Do rail fares have VAT? Notably, certain services and goods are exempt supplies and fall outside the UK VAT system. These are not subject to VAT and include:

  • Insurance -this is taxable through the insurance industry.
  • Flights -these are 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 seen as `essentials’.

Some goods and services also have a reduced 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

When your business supplies digital products or services to a client in an EU country, the VAT to charge is based on the customer’s country’s VAT rate.  Your business will also need to register for the VAT Moss scheme and submit Moss returns in the future.

Guide to VAT -the reverse charge procedure

This seems like a complicated solution to a straightforward issue; 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:

  • One of the services covered by the general rule for place of supply of services.
  • Certain other services.

When dealing with the reverse charge, you will calculate the amount of VAT (output tax) on the total value of the services supplied to you. On your company’s VAT Return, you will enter:

  • The amount of VAT you calculated in box 1.
  • If you are entitled to reclaim some or all of the VAT on your purchase of these supplies, you will 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.

Other thoughts

As mentioned in this VAT guide in the UK, customers and clients that are VAT registered can reclaim the VAT that you charge to them. It is not 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 you are VAT registered and can reclaim their input VAT too.

Your accountant will typically take care of your contractor VAT registration for you. This is one of the first tasks they will carry out when you set up a new company.

Guide to VAT -types of VAT schemes 

There are several different VAT schemes available when you are VAT registered. This 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 have charged on invoices raised during the VAT period.

minus

Any VAT you have incurred 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 have received the funds from your customers and clients. Similarly, you can only reclaim VAT on purchases and expenses when you have paid the supplier. This scheme is useful for cash flow purposes. Most contractors who register for VAT operate under the cash accounting scheme. 

Flat Rate VAT scheme

This VAT Flat Rate scheme is a sub-scheme that many limited company contractors would have often used in the past.

However, contractors rarely use this nowadays as it is no longer as beneficial as it used to be. HMRC initially brought this scheme out to make accounting easier. Under this scheme, you would still invoice clients at the standard rate, but you would pay HMRC a fixed percentage rate of your gross quarterly turnover, depending on the industry in which you operate. For IT contractors, the rate is 14.5%, and in the first year of operation, the contractor can also benefit from a 1% reduction to the fixed rate.

However, in April 2017, the new ‘limited cost trader’ rules came in. They removed most of the benefits of using the VAT Flat Rate VAT scheme for most small businesses, particularly those with low quarterly costs. If you do not 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 is the same as 19.8% of the net. The standard VAT rate is 20%. Therefore, you would only save 0.2% under this scheme. On a £10,000 + VAT invoice, the saving would only be £20.  Thus, operating under the standard VAT scheme (Cash Accounting scheme mentioned above) is one of our handy tax tips for contractors and small business owners.

VAT for contractors -correction of VAT errors 

If you discover an error after you have submitted a VAT return the options are:

  • If the error is under £10,000 it can be corrected via your next VAT return.
  • If the error is over £10,000 it will need to be reported to HMRC via form VAT652. 

Penalties 

VAT penalties

There are penalties for no VAT registration or late VAT registration. There can also be fines for the late payment of VAT bills that can be pretty hefty. Therefore, it is key that 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 VAT filing deadline. If this occurs, the business will receive a letter from HMRC. It will state that HMRC will place the company on a `warning’ for the next twelve months.

If the following four VAT returns and payments are all submitted to HMRC on time, HMRC will remove the `warning.’ However, if the business is late within twelve months, HMRC will write again and place the business on the next level of `warning.’ 

More on VAT penalties

If you are late filing or paying your VAT several times in a row within twelve months of the last late return, this will increase the warning level each time. After four or five of these in a row, HMRC will start to charge financial penalties (2%, 5%, 10%, up to 15% of the actual VAT bill). They will charge this % on top of the VAT bill payable for repeated late returns.

You must improve your submission time to ensure that HMRC will remove any warning level. The following four returns and payments in a row will need to be on time to remove the warning.

It is clearly in your best interest to avoid these penalties. What’s more, if you are consistently late, it will result in increased scrutiny from HMRC, and they may take a closer look into your affairs. Therefore, you should ensure that you or your accountant are processing your VAT returns on time. You could also set up a direct debit so you will never miss a payment (but this relies on the return being filed first).

VAT for contractors -obtain advice

This VAT for small businesses and contractors guide should have given you a good insight into how VAT works. Your accountant, however, will be able to advise you which scheme is most suited for you.

Today it is better for contractors to operate under the standard VAT scheme, rather than the not VAT Flat Rate scheme. That is unless they qualify as a limited-cost trader under the Flat Rate Scheme, which in most cases is unlikely. We would also recommend the Cash Accounting choice.

VAT de-registration 

When your business has finished trading and it needs to de-register for VAT, it can do so through the VAT service in your HMRC Business Tax account. There is an option to de-register with the options on the main screen and once you have selected this you can follow the procedure online. You will need to pick a date for your de-registration and there are 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 application is submitted, HMRC will write to you to confirm the business is de-registering and it will let you know about any final VAT return form to complete. The final return can be filed via your online software and, once you have done this, there should be nothing more to do on VAT.

Furthermore, if you have incurred any VAT that you have not claimed via your VAT returns, you can claim this back via form VAT427.

Final thoughts

As you can see from this HMRC VAT guide, VAT is a very complex area with many VAT rules to bear in mind. This is one of your main contractor taxes and you can easily get lost if you are not sure. 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

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Published On: August 1st, 2022 / Categories: Company Taxes, Guides, Tax Guides /

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