VAT guide For UK small business

Introduction

This HMRC VAT guide is a handy reference point as it covers VAT for UK contractors and small business. It is an in-depth guide and covers many of the aspects to consider, when your business is VAT registered.

When you are running your own company and you are VAT registered, it is useful to know how VAT works.

For the layman, VAT can be quite complex, and the technical bits can even confuse a very bright person.

Therefore, we have created an easy-to-follow VAT guide which covers the basics for the UK VAT system.

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

What is VAT? 

VAT stands for Value Added Tax. This is the UK business sales tax or trading tax and most countries have such a tax. VAT is chargeable by VAT registered businesses on most goods and services that they provide to their customers.

The standard VAT rate in the UK is currently 20%.

If you are a VAT registered business, you will more than likely need to add VAT on to your services or sales, at a rate of 20%.

The types of costs that do not include VAT 

There are certain services and goods that 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’.

There are also some goods and services that have a reduced rate of VAT and these include home energy and children’s car seats. During the recent pandemic, there was also a reduced rate of VAT given to the hospitality sectors. This ended on 31 March 2022.

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.

If a business exceeds the 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 certain services and goods as well as 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, you should keep your eye on this on an ongoing (annual) basis.

Voluntary registration

As part of this guide to VAT, it is important to note that a business can choose to register voluntarily, if its business taxable 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.

The actual registration process 

Today, you can apply for VAT registration online, unlike the old paper forms in the past. Importantly, the online registration process is now a much quicker turnaround time. 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 at the same time. Please note, the postal route is still available, however this will take much longer.

Once you submit the VAT registration application form online, it will normally take two working days to receive your VAT registration number. Once your VAT number comes through in a message from HMRC, you then need to 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 will be able to download your VAT certificate.

The things to bear in mind when you are VAT registered

Initial considerations   

As a VAT registered business, clients may request to see your VAT certificate.

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 need to add VAT to your invoices at 20%.

Further considerations

As part of this HMRC VAT guide, please note that if your customers are VAT registered themselves, they can reclaim the VAT that 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 themselves. 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 to 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 you register for VAT, it is worth having a chat with your accountant. They can advise you what is best in your circumstances.

Charging and reporting VAT   

Charging VAT on your sales invoices 

In this guide to VAT, we now look at when you first need to start charging VAT on your invoices. The date that you first register for VAT with HMRC is your `registration date.’ Your choice here is the day that you would like to start to charge VAT on your goods or services.

If you have applied to register for VAT and are waiting for your VAT number, and you need to raise an invoice to a customer or client, you cannot charge VAT as you do not yet have your VAT number. As mentioned above, today, it usually takes two days for your VAT number to come through. Therefore, in most cases, you will be able to wait until you receive this before you raise your invoice and charge VAT on this.

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, 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 will need to include your VAT number on all of your invoices to your customers and clients.

VAT return period 

In this HMRC VAT guide, we look at what periods VAT returns cover. Unless reporting on the Annual VAT Scheme, VAT returns cover three-month periods. Therefore, depending on when HMRC set your first VAT return, the VAT period 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 VAT returns monthly, and you may opt for this if you are due regular refunds from HMRC. This could occur if the majority 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 filing 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, if your VAT return ended on 31 January, you would need to make sure 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.

Making Tax Digital (MTD) 

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

This is the method of digital reporting of your VAT return figures to HMRC. All businesses that are VAT registered, now submit their VAT returns via MTD online accounting compliant software.

The popular software choices for businesses currently include FreeAgent, Xero, and others.

Output VAT and Input VAT   

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

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

The actual VAT return 

The VAT return contains nine boxes that you need to complete on each VAT return. What’s more, for the `normal’ contractor, they will only need to complete the following boxes:

1 The VAT on sales –output tax.

4 The VAT on 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:

a) pay to HMRC or

b) HMRC needs to refund to your business. If there is a VAT refund that is due, HMRC will repay this.

Reclaiming 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 costs and expenses that include VAT. Therefore, going forward, the actual cost of these to your business will be the amount before VAT. When you are claiming back VAT, you will need to obtain and retain any invoices or receipts that relate the amount of VAT that 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.

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 that are 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 full 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 full value of the supply in both box 6 and box 7.

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

Other thoughts 

As mentioned in this guide to VAT, 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 when you are VAT registered it can help create a more professional image for your business. As a result, the customer may then be more inclined to use your business again soon, knowing that you are VAT registered and that they can reclaim their input VAT too.

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

VAT schemes

There are different VAT schemes that are available. In this guide, we now look at what HMRC offer 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 that you have incurred out 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 for them. This scheme is useful for cashflow 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 very rarely use this nowadays as it is no longer as beneficial. 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, please note, from April 2017, the new ‘limited cost trader’ rules came in. They removed the majority of the benefits of using the VAT Flat Rate VAT scheme for most small businesses, particularly those with low quarterly costs. The change in effect, was if you did not qualify under the new rules, you would instead pay over 16.5% of the gross amount invoiced.

This change was a sneaky one, as 16.5% of the gross is the same as 19.8% of the net. The normal 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.  Therefore, in general, operating under the normal VAT scheme (Cash Accounting scheme mentioned above) is one of our handy tax tips for contractors and small business owners.

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 fairly 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.

Provided that the next four VAT returns and payments are all submitted to HMRC on time, HMRC will remove the `warning.’ However, if the business is late again within twelve months, HMRC will write again and place the business onto the second 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 result in the warning level moving up each time. After four or five of these in a row, HMRC will start to charge financial penalties (2%, 5%, 10% up to a max of 15% of the actual VAT bill). They will charge this % on top of the actual VAT bill payable for repeated late returns.

To make sure that HMRC will remove any warning level, you will need to improve your submission time. For you to remove the warning, the next four returns and payments will need to be on time.

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 make sure that you or your accountant are processing your VAT returns on time. You could also set up a direct debit so that you will not ever miss a payment (but this does rely on the return being filed first).

Obtain advice 

This guide to VAT should have given you a good insight. 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 `normal’ (not VAT Flat Rate) scheme. That is, of course, 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.

Final thoughts 

As you can see from this HMRC VAT guide, VAT is a very complex area and there are lots of VAT rules to bear in mind. You can easily get lost if you are not sure. We hope that this guide has given good insight, but if you have any questions yourself, you should check these out with your accountant.

Link to Contractor Advice UK group on

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

Published On: March 29th, 2021 / Categories: Company Taxes, Guides, Tax Guides /

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