VAT for your small business

Value-added tax (VAT) is one of the most important areas of business tax to get right.

Not only can it be a big challenge in terms of accounting, but it can also affect your competitiveness and your profit margins.

Handling VAT effectively is, therefore, a fundamental part of running any successful small business – it’s not just about keeping HMRC happy.

What is VAT?

VAT is a tax on most goods and services levied at the point of sale. This increases the retail price of anything liable for VAT.

As a business, most goods and services you buy from suppliers will have VAT added to the price. You may also have to charge VAT to your customers.

The standard rate of VAT is 20%, although there are other rates on certain products and services.

Managing VAT is a juggling act as you must determine how much VAT customers should pay you, how much you must pay suppliers, and how much you need to pay (or reclaim from) HMRC.

Should I register my business for VAT?

You can only reclaim VAT if you are VAT registered, and if you are, you must also charge it.

If your business turns over more than £90,000 of VAT-able goods or services (i.e. those not exempt or zero-rated), you must register for VAT.

If you turn over less than this, then you can still choose to register for it.

There are upsides and downsides to doing this, so you will need to weigh these up to see which option is best for your business.

The advantages of being VAT-registered

Registering your small business for VAT, even if your business has a turnover below the £90,000 threshold, can have several benefits.

Firstly, if you buy a lot from suppliers who charge VAT, you can claim this money back against the VAT that your business charges.

For example, if you buy £10,000 of stock and services you have to pay VAT on from your suppliers, you’ll pay £12,000 in total – £2,000 of which is VAT.

If you then make sales of £12,000 that are eligible for VAT to your customers, around £2,000 of this will also be VAT. In this example, your net VAT bill would be zero.

Of course, you’d hope to make more in sales than you spend on suppliers, so your VAT bill should be a positive figure, but being able to reclaim VAT may lower your overall costs.

The second potential advantage of being VAT registered is that other businesses may prefer working with you, as it gives the impression the company is larger and more established - even if you’re just starting out.

The disadvantages of being VAT-registered

There may be a few drawbacks to being VAT-registered if your taxable turnover is under £90,000.

The most obvious is you’ll have to charge VAT on your taxable products or services, which will either make them more expensive or reduce your margins (or both).

A small business whose main selling point is low prices may, therefore, benefit by not being VAT registered (though you would still have to pay it when buying stock you need to pay VAT on).

The other downside to being VAT-registered is the administrative burden.

You will have to submit quarterly VAT returns and to ensure these are accurate, you will probably need an accountant.

What are the different VAT rates and what do they mean?

The standard rate of VAT is 20%, but some products and services have a lower rate of VAT, a zero rate, or are fully exempt.

What is the difference between zero-rated and exempt from VAT?

You may wonder how a product zero-rated for VAT differs from an exempt product.  The difference lies in whether or not your business can register for VAT and reclaim it.

If a business only sells products or services exempt from VAT, it cannot register for VAT (and can’t reclaim VAT charged by its suppliers).

However, if your business sells zero-rated products or services, you can still register for VAT and reclaim any VAT charged by your suppliers, even though you won't charge your customers for it.

If your business offers a mix of goods and services, some of which are zero-rated and others exempt, VAT accounting for these can get quite tricky.

An accountant will have to establish how much VAT you can reclaim on goods and services you have purchased based on the extent to which these help deliver your own products that are subject to VAT.

For example, you can’t reclaim VAT on any sporting goods you use to deliver a sports class, as the class itself would be VAT-exempt.

Some businesses may offer a wide range of products that are standard rate, reduced rate, zero rated and exempt from VAT.

All will need to be carefully accounted for so that the right amount of VAT is reclaimed.

How to register for VAT

You can register for VAT online on the government’s website. Remember that you must do this if your VAT-taxable turnover is over £90,000.

Once registered, you’ll receive a VAT registration certificate confirming your VAT number and when your first return and payment are due.

You must register within 30 days of the end of the month when your turnover went over the threshold. The effective date of registration is the first day of the second month following your turnover exceeding £90,000. 

If your turnover has exceeded £90,000 temporarily, you can apply for a registration ‘exception.’ 

Contact HMRC to request the VAT1 registration form. You’ll be expected to provide evidence showing why your taxable turnover will not exceed the deregistration threshold of £88,000 in the next 12 months.

How long does it take to register for VAT?

Once you've submitted your application, you can expect to receive your certificate in around one month.

However, you must start accounting for VAT on the date you submit your application, so keep careful records during this month (and from then on).

Can I reclaim VAT on purchases made before I registered?

You can make backdated VAT claims on products or services you bought before registering for VAT.

You can reclaim VAT from up to four years before the date of your registration, provided it was paid on goods you still own or that were used to make goods you still own.

For services, there is a shorter deadline, as you can only reclaim VAT for services bought up to six months before the date of your registration.

All such goods or services must be for the business you have registered for VAT.

It is best to reclaim them on your first VAT return and ensure you still have all relevant invoices and receipts, along with information as to how these purchases relate to your business.

Do I need an accountant to handle my VAT?

Unless your business is very small, VAT accounting can become burdensome quickly.

In particular, if you are over the £90,000 taxable turnover threshold, you will want to ensure your VAT returns are as accurate and efficient as possible.

At best, mistakes can reduce your margins, and at worst, they can trigger an investigation from HMRC.

There are VAT schemes you can join to make submitting your filing easier. For example, the VAT Flat Rate Scheme lets you work out what you owe HMRC in VAT as a percentage of your gross turnover.

You can only use this scheme if your business has an annual taxable turnover of £150,000 or less, excluding VAT.

Also, if your annual VAT taxable turnover is £1.35 million or less, you may be able to join the VAT Annual Accounting Scheme or the VAT Cash Accounting Scheme. 

The VAT Annual Accounting Scheme enables firms to complete just one VAT return each year instead of four, while the VAT Cash Accounting Scheme enables you to pay VAT when your customer pays you rather than when you invoice them.

However, an accountant can advise you on the best course of action and ensure the whole process goes smoothly. You can find a qualified accountant via Unbiased today.