Should I Register For VAT?

Not much value added by this tax!

What is VAT?

Value Added Tax is a tax on consumption paid by the ultimate user of the goods or services. Once you register for VAT it is your job to collect VAT from your customers and forward it onto HM Revenue and Customs. There are no rewards for this public service(!) but plenty of penalties if you get it wrong.

How does VAT work?

Once you reach the registration threshold you must register for VAT and then add VAT to everything you supply, at the appropriate rate. You then account for this on your VAT Return. You must register for VAT when your sales reach £73,000 (at YE April 2012). This figure normally goes up in the Chancellor’s annual budget.

There is a catch though…

It’s sales turnover of £73,000 in the last twelve months, not in a financial year. So if at this month end your last twelve months turnover is about to go over then you must register to become a VAT collector. In practice that means average monthly sales of £6,084 or more.

Once registered, you add VAT to everything you sell, which for most of us means charging our customers an extra 20% on top of our prices.

Because it is your job to collect VAT you need to keep careful notes of how much you charge and collect. You also need to keep VAT receipts for everything you buy for your business. Once registered, you add VAT at these rates:

Rate Example
Exempt supplies You cannot register for VAT if you only make exempt supplies. These include things like some land and buildings plus burial services.
Zero rate Some food, books, children’s clothes
5% reduced rate Domestic fuel, contraceptives, smoking cessation products
20% standard rate Applies to the majority of goods or services you supply.

Because it is your job to collect VAT you need to keep careful notes of how much you charge and collect. You also need to keep VAT receipts for everything you buy for your business.

The VAT Return

Once every three months you will get a reminder email which asks you to make your VAT return online. You need to make five basic entries:

For this example, let’s assume I made a sale of £120 (inc. VAT) and spent £14.40 (inc. VAT) on business expenses. So I charged my customers £100 and collected £20 from them in Value Added Tax. I spent £12 on business expenses but the supplier collected an extra £2.40 from me in Value Added Tax. So I would fill my VAT return in like this:

Item £
Enter VAT collected during the period £ 20.00
Enter VAT reclaimed on your purchases £ 2.40
Take one from the other to show the amount of VAT you are sending to the Revenue or the amount of VAT they need to refund you for this period £ 17.60
As a double check they also ask for your net Sales figure £ 100.00
And your net Purchases figure £ 12.00

If you trade with the European Union there are some other entries to make. You can already see that VAT accounting is a pain so you need to be well organised and get into the habit of asking for and keeping VAT receipts for everything you buy.

VAT and customers

If your customers are mainly businesses then VAT is a non-issue. Why? Because they simply take the VAT you charge them and reclaim it as VAT on purchases - it gets knocked off their VAT bill.

If your customers are not VAT registered then VAT may be a problem for you, especially if your competition is not charging VAT. If this happens you will either be 20% more expensive than them or have to lose money by keeping your prices the same.

How to calculate VAT - 20%

To work out the VAT on the VAT inclusive price, use the VAT Fraction (1/6)

To work out how much VAT you should add, simply multiply by the rate (20% so use 1.2)

E.g. You sell something at standard rate with a value of £100. You need to add VAT of £20.00 (100 x 1.2) to make the final selling price £120.00.

E.g. To find the VAT in an item bought for £120 then the calculation is £120/6 and then x 1 = £20. So the original price was £100 + VAT.

Note that £20 is not 20% of £120. Find the correct amount of VAT by using the VAT fraction (1/6) rather than the % button on your calculator.

The decision you face

Those are the basics of VAT. As you can see, it is a tax collecting job that requires you to be very careful with the paperwork. The decision you face when starting a business is whether to ignore VAT registration until your sales rise to the threshold or whether to register now. Let’s look at the arguments for both.

Three reasons to put off VAT registration

Hassle - It’s a lot of paperwork and fuss. You have to be precise and up to date. You have to use the online filing facility.

Need - if you are never going to make the threshold, why bother?

Domestic clients - if you have domestic clients you may want to put it off as long as possible because VAT registration means a price increase.

Three reasons to register early

Claim - registering for VAT now means that you can start to reclaim the VAT on things purchased for your business. BUT you will have to start charging your customers VAT.

Customers - some customers will not deal with you until you are VAT registered.

Credibility - VAT registration helps you look like a “proper” business. If your clients worry about IR35 then it also helps to show the Revenue that you are not an employee.

Making VAT easier for smaller businesses

To their credit HMRC have devised three ways of administering VAT that make life easier for the smaller business:

CASH ACCOUNTING

This is actually a default scheme for a smaller business. It means that you run your VAT account on a cash basis. You only account for VAT you collect when you actually receive the money. You only claim VAT back on actual spending.

This is much easier than the situation in a bigger business where they have to account for VAT when they issue the invoice, well before they have actually been paid.

ANNUAL ACCOUNTING

As the name suggests, this VAT scheme enables you to complete one VAT return a year instead of four. You pay something on account either monthly or quarterly and reconcile it with a single annual return. It’s very similar to a budget payment plan.

The major advantages for you are predictable payments for most of the year and you get to hold onto the VAT you collect for a lot longer. This might be helpful for cash flow.

FLAT RATE SCHEME

Under this scheme you work out your VAT bill by applying a flat rate percentage to your gross turnover. The rate depends on which trade sector you are in. View the list of Flat Rate Scheme percentages. This scheme does away with the need to keep receipts and onerous paperwork. You still charge your clients the full rate but you can no longer claim back VAT on your purchases. This means that the Flat Rate Scheme is NOT a good idea in the early days when you want to be able to reclaim all your actual costs.

How do I join these schemes

There are two main ways to join these schemes and in both cases you have to apply and wait for the VAT people to approve you - either go to the HMRC website, read more about the Flat Rate Scheme or call the VAT National Advice Service (below).

Take action on VAT

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