A complete guide to sole trader VAT registration and compliance

What is VAT?

Value added tax (VAT) is a consumption tax added to most goods and services sold in the UK.

Every time a product or service moves along the supply chain, from raw materials to manufacturing to final sale, value is added. VAT is charged on that added value at each stage.

Businesses registered for VAT act as collectors for HMRC. They add VAT to the price of their goods and services and pass this on to their customers.

The good news for businesses is they can generally reclaim the VAT they've paid on their own business expenses, which helps to ensure only the final customer pays the tax.

Do sole traders pay VAT?

If your turnover as a sole trader is less than £90,000 in any 12-month period, you don't have to register for VAT. This means you don't charge VAT on your sales, but you also can't reclaim VAT on your expenses. 

On the other hand, If your turnover exceeds £90,000, you must register for VAT, which means you'll need to charge VAT on your sales, submit VAT returns to HMRC (usually quarterly), and keep accurate records of your income and expenses.

It’s also worth keeping in mind even if you haven't reached the £90,000 threshold yet, you must register for VAT if you expect your turnover to go over this limit within the next 30 days.

What is the VAT registration process for sole traders?

Sole trader VAT registration is done by following these steps:

1. Gather your information, including your national insurance number, business bank account details, details about business activities, and turnover for the last 12 months.

2. Create a Government Gateway account, which is your personal account for accessing online government services, including those provided by the HMRC.

3. Once you have a Government Gateway account, you can access the VAT registration portal on the HMRC website.

4. Follow the instructions on the screen and provide the necessary information about your business.

5. Review your information carefully before submitting it to HMRC.

6. Wait for confirmation.

How is VAT charged, and how do you manage your records as a sole trader?

As a VAT-registered sole trader, you must charge VAT on most goods and services you sell.

The first step is determining the correct VAT rate, but most goods and services fall under the standard rate of 20%.

A few items, such as children's clothes, are zero-rated, meaning no VAT is charged, while others, like children’s car seats and domestic fuel, sit in the reduced VAT bracket of 5%.

Once you know the rate, calculating the VAT is simple.

Multiply the price of what you're selling by the VAT rate, so by 1.05 for the 5% rate or by 1.20 for the 20% VAT rate. 

For example, if you're selling a service for £100, and the standard 20% rate applies, the VAT would be £20, which is added to your original price to get the final price of £120 that your customer pays.

How to reclaim VAT as a sole trader

Reclaiming VAT as a sole trader is possible on all goods and services you've purchased for your business, provided they're used exclusively for business purposes, such as:

• Materials
• Office supplies
• Equipment
• Services
• Fuel

To reclaim VAT, you must keep valid VAT invoices for all purchases, including the supplier’s name and address, their VAT number, invoice date, a description of goods or services, and the amount of VAT charged.

It's extremely important to keep these invoices organised and accessible, either digitally or in paper format.

Reclaiming VAT is only successful when you submit your VAT return to HMRC.

VAT returns are usually submitted quarterly, and you'll need to provide details of your total sales and the VAT you charged, as well as your total purchases and the VAT you paid.

What are the drawbacks of VAT registration for sole traders?

VAT registration offers benefits like reclaiming VAT on expenses and increased credibility.  

However, it also comes with drawbacks. These drawbacks include a more significant administrative burden with record-keeping and returns, potentially higher prices for customers, and possible cash flow challenges while waiting for VAT refunds.

What happens if you don’t register for VAT?

If you don't register when you should, HMRC may investigate and fine you a penalty fee, including surcharges, interest on what you owe, and potentially criminal prosecution in severe cases.

You'll also have to pay VAT retrospectively, regardless of whether you didn't charge it initially, which might seriously damage your business's finances and reputation.

Get expert financial advice

Reclaiming VAT as a sole trader can reduce your tax burden. For this and many other reasons, including staying on the right side of the law and avoiding penalties, VAT is an important aspect of doing business within the UK. 

Knowing how the VAT system works, the requirements you need to meet, and how it benefits you will ensure you remain compliant and able to take advantage of any possible tax breaks. 

Get matched to a professional financial adviser or accountant via Unbiased for expert advice and to ensure your tax affairs are always in order.