Accountants love VAT – it’s about the only bit of what we do with any good jokes.
Are Jaffa Cakes biscuits? Should sleeved-blankets, AKA slankets, be zero-rated? Is banana-flavoured Nesquik rated the same as chocolate flavour?
There’s just something funny about the idea of judges and QCs having to think really hard about these questions, especially when the only way they can decide is by having a tray of cakes brought into the court for context.
For business owners and operators, though, it’s no laughing matter. Since it was introduced almost 50 years ago, the UK VAT system has proven ridiculously complicated.
There are different rates for different products and services, extra fiddly rules for exports, and a choice of accounting schemes. It’s no wonder my VAT service clients have so many questions.
On top of that, if you get it wrong, it’s not unusual to get hit with a big unexpected tax bill, face fines for late payment or inaccurate returns or, worse, end up at tribunal yourself. That’s a particular problem if your business is built on innovation, selling something new or genuinely different.
There’s also Making Tax Digital to think about. Although HMRC hasn’t got heavy about enforcement yet, most VAT-registered businesses are expected to keep digital records and submit VAT returns through approved software.
This is a quick guide designed for absolute beginners – especially people who’ve just started out in business. If you’re still confused after you’ve read it, contact me with any questions you’ve got.
Do I need to worry about VAT?
You need to register for VAT if your taxable turnover goes over £85,000 in any 12-month rolling period.
We’re not talking about the tax year or financial year here – it could be any 12-month stretch.
That’s why it’s important to monitor your turnover as part of your management accounts, especially if you know you’re hovering around the threshold.
If you’re over that VAT-registration threshold and aren’t registered, or you’re likely to exceed it anytime soon, get in touch now and we’ll help you get sorted as soon as possible through our VAT service.
What is VAT and how does it work?
VAT stands for value-added tax and is a form of what is sometimes called ‘sales tax’ in other countries.
It’s applied whenever ‘value is added’ to a product as it passes along the line from manufacturer to end buyer.
The tax is paid by the consumer with the seller acting as an unpaid tax collector on behalf of the Government – calculating, reporting and paying VAT over to HMRC.
Because the seller usually passes the cost of VAT on to the buyer, it can mean that VAT-registered businesses end up seeming to charge more for the same products.
This can sometimes be an incentive for businesses to hold back on growing because they know when they do, they’ll either have to put up prices or absorb the impact of VAT.
What are VAT rates?
There are different rates of VAT depending on what you’re selling.
- Standard rate | 20% | applies to most goods and services.
- Reduced rate | 5% | on certain goods and services.
- Zero-rate | 0% | for selected items such as most food, books, newspapers and children’s clothes.
Some things are also VAT-exempt which, confusingly, isn’t the same as being zero-rated. Insurance, education and training services and commercial letting are all exempt from VAT.
I did say it was annoyingly complicated, didn’t I?
The VAT of specific items isn’t always intuitive or obvious. For example, that Jaffa Cake example above comes up time and time again because it highlights a particular bit of weirdness:
- Cakes are zero-rated
- Biscuits are also zero-rated
- But standard rating applies to chocolate-covered biscuits.
If you’re not sure, talk it through with an expert – but don’t just guess, especially not if you’re prone to wishful thinking.
How to register for VAT
Most people can register online via the Government Gateway website, though there are a few exceptions.
You can also register via an agent – usually an accountant, like me.
Either way, you’ll need to supply a National Insurance (NI) number, details of other businesses you’ve owned in the past two years and banking details. If you bought the business, you’ll also need to have a record of the purchase.
Once you’re registered, you’ll get a VAT-registration certificate that sets out:
- your VAT number
- the deadline for your first VAT return and payment
- your ‘effective date of registration’.
Most businesses need to file a VAT return every three months, unless they’re using one of the variant accounting schemes.
VAT accounting schemes
Working out which VAT accounting scheme is best for your business can save you time, effort and money.
The three main schemes are:
- Flat-rate.
- Cash accounting.
- Annual accounting.
The flat-rate scheme offers businesses with a turnover of no more than £150,000 (excluding VAT) the option to pay a fixed rate – usually somewhere between 4% and 14.5%. The idea is to make VAT cheaper to administer and enforce by simplifying the rates. But be aware that with this scheme, you can’t reclaim VAT on most purchases.
Under the cash accounting scheme you can pay VAT on sales when your customers pay you, as opposed to the date when you invoice. As long as your business turns over less than £1.35 million, you’ll be eligible for this scheme. The downside is that you can’t reclaim VAT until you’ve paid your supplier which might not work for you if you buy stock on credit.
Finally, the annual accounting scheme gives you the option to make advance payments towards your VAT bill throughout the year and then complete a single annual return. Again, your estimated taxable turnover needs to be under £1.35m.
Cloud accounting makes VAT easier
Since 1 April 2019, most VAT-registered businesses have been obliged to comply with Making Tax Digital (MTD) – HMRC’s scheme to digitise the VAT system.
If you’re about to register for VAT and wondering how to go about keeping digital records and submitting VAT returns digitally, the answer is cloud accounting software.
Both Xero and FreeAgent are MTD-compatible and take a lot of the stress out of dealing with VAT.
Talk to us about VAT registration and MTD for VAT.