VAT: What you need to know when running a small business
We’re all used to seeing Value Added Tax (VAT) as a common item on many bills and receipts. But is VAT relevant for small businesses? Is VAT something that every business needs to charge? What are the pros and cons of VAT registration?
These are the common questions our clients ask us every day.
In this article, we’re going to look at what VAT is, why it’s important to your business and whether you need to be VAT registered.
Armed with that information, you’ll be able to make the right decisions to help your business grow.
What is VAT?
The term VAT – short for Value Added Tax – is generally understood throughout the European Union as a percentage charge paid by consumers when purchasing certain types of goods and services.
Other countries have different names for the same general concept. For example, Australians have the Australian Goods and Services Tax (GST). As we provide accountancy services to UK businesses, we’ll stick with talking about VAT.
Since January 2011, the VAT rate in the UK has been 20% for most goods and services. There are some exceptions – for example, children’s clothing and footwear attracts a zero rate for VAT.
Rather than focusing on the details of how VAT is charged, we’re going to look at the broad pros and cons about being VAT registered, so that you can understand what really matters for your small business.
It’s commonly assumed that charging VAT is something that all businesses do, so it’s no surprise that many people who speak to us about starting their own business assume that they need to be VAT registered with HMRC.
In fact, that’s not true.
Many small businesses do not need to be VAT registered.
Businesses in the UK need to register for VAT only if their annual taxable turnover in the last 12 months or the next 30 days is greater than the VAT threshold. This figure is set and reviewed by the government, with any changes announced in the Chancellor’s regular budget statements.
The current VAT threshold is £85,000 and will be unchanged until 1 April 2022 at the earliest. (Last reviewed on 01/07/2020)
If your annual turnover is below the threshold, you can still voluntarily register for VAT. The decision is totally up to you.
Why would I register for VAT if I don’t have to?
You might wonder why you’d want to register for VAT if you’re not legally obliged to.
Registering means you have to regularly send VAT returns to HMRC as well as increasing the amounts you charge to your customers. Wouldn’t it be better to sidestep that hassle if you could?
Well, yes and no.
It makes sense that as business owners we want to keep our paperwork to a minimum. And we certainly don’t want to charge our customers more than we need to – it’s a competitive world out there and pricing matters.
On the other hand, being VAT registered can add an air of authority and permanence to your business.
And if most or all of your customers are VAT-registered businesses, the VAT they pay you for goods and services is often reclaimable. That means they might not be too worried about the VAT component of what they pay you because they’re able to claw back some or all of it.
Here’s another reason why voluntarily registering for VAT can make sense. Registering means that your clients and competitors won’t necessarily know what your annual turnover is. But if you don’t register for VAT, you’re effectively announcing to the world that your annual turnover is less than the VAT threshold.
In many cases, this won’t matter. But there may be some prospective clients who will feel more comfortable dealing with a VAT-registered business, especially if they’re likely to spend a lot of money buying from you.
One of the most common reasons to register for VAT voluntarily (i.e. before turnover creates an obligation to register) is to recover VAT incurred in start-up costs. For example, a new coffee shop may spend significant sums on creating a café and buying equipment. The VAT element of those costs can be reclaimed and return that cash flow to the business sooner than waiting until turnover exceeds £85,000.
We’ve already hinted at the drawbacks of registering for VAT. You’ll need to submit VAT returns to HMRC four times per year and you’ll need to account for VAT on taxable income regardless of who the client is.
If your turnover exceeds the VAT threshold, there’s no decision to be made – you’re legally required to register for VAT.
Do I have to register for VAT even if I’m a sole trader?
If your annual turnover is above the VAT threshold then the answer is yes. There are no special exemptions from VAT registration just for sole traders or partnerships.
As with limited companies, sole traders have to register for VAT if their annual turnover exceeds the VAT threshold.
If your annual turnover falls below the VAT threshold, you don’t need to register for VAT – but you can register voluntarily if you wish.
How do I register for VAT?
You can register for VAT via Gov.uk’s VAT registration pages.
This applies whether you decide to register voluntarily or whether registration is compulsory (because your annual turnover exceeds the VAT threshold).
How does VAT work once my business is VAT registered?
Once your business is registered for VAT, you’ll gain access to the part of the Gov.uk website that will let you complete your VAT returns. From the VAT point of view, the year is generally split into quarters, meaning that you’ll need to log in to the website four times per year to submit an online VAT return.
You’ll be given a VAT number. You’ll need to include this on all sales invoices you issue from that point onwards. You won’t need to worry about changing or re-issuing any invoices you issued from before the time you were VAT registered. For this reason, it’s important to keep a note of your effective date of VAT registration.
As well as quoting your VAT number on your invoices, you’ll need to add the relevant VAT charges to your invoices. In most cases, this means adding 20% (the current VAT rate) to the net charge.
At the end of each quarter, you’ll need to log in to the Gov.uk site to complete your VAT return – that’s the point where the VAT you’ve charged is declared to HMRC.
The VAT return is a summary of your earnings (which includes the VAT you’ve charged for your goods and services) plus your expenses (which includes the VAT you’ve paid for goods and services). The difference between these amounts will determine how much you need to pay or claim in your quarterly VAT return.
The summary above covers the most common way of registering for and running your VAT account. There are other methods of handling VAT, including the cash-accounting method and the Flat Rate Scheme. These have their own pros and cons, and discussing them in detail goes beyond the scope of this article. However, if you need advice on which method may be best suited for your small business, that’s something we can discuss during a consultation call.
Do VAT rules differ across the UK?
No. Whether you’re in Dundee or Dorset, the VAT rules are the same across the UK. Thresholds, percentages, forms – it’s all identical.
That’s good because we know that our VAT advisory service can offer you the same even-handed advice regardless of where in the UK your business is based.
What if I have questions about VAT?
HMRC publishes plenty of guidance about VAT and VAT registration via the government’s website. Specific questions are often best directed to HMRC’s telephone helpline. Be prepared to wait for your call to be answered and don’t expect an expert personal consultation that deals with every possible financial question.
Though we can’t make specific recommendations here, we do have many years of experience in helping new business owners get up and running. If you book a consultation call with us, we can take the time to walk you through the facts, showing you how VAT may be relevant to your business. To find out more, get in touch with Alan below.
Like all important decisions, you have to choose the path that you feel is right for you. Our job here is to present the facts in a clear way so that you have the best possible chance of making the best choice for you and your business.
You can find out more about our corporate tax and VAT advisory services on our VAT page.
OK, we’ve taken a look at VAT registration and have hopefully given you some useful points to consider.
While we can’t say what’s best for your business, we can invite you to talk to us so that we can understand more about where you are and where you want to go.
We’ve got just the right person for you – Alan Davis, our Chairman. Alan worked for HMRC for 16 years and is one of our VAT specialists.