Value Added Tax (VAT) is a tax which is levied on the sale of good and services by VAT registered businesses in the UK. Despite businesses having responsibility for collecting and reporting VAT to HMRC; VAT is not a tax on businesses, it is ultimately borne by consumers having been passed down the supply chain via the selling price of goods/services, and VAT registered businesses reclaiming VAT on their inputs (taxable purchases).
There are three rates of VAT that can be applied to taxable supplies of goods and services in the UK:
Not all supplies of goods and services are treated as taxable, those that are exempt from VAT and as such no VAT will be charged or reclaimed on these supplies. Examples include insurance, education, financial services.
Historic Turnover Test
The historical test is performed at the end of each calendar month, and when performed, if the value of taxable supplies for the past 12 months exceeds the VAT registration threshold, then the business must notify HMRC within 30 days. The business becomes liable to VAT on the first day of the next month.
Future Turnover Test
The future test applies continuously in that if there is reason to believe that the value of taxable supplies in the next 30 days alone will exceed the VAT registration threshold, then the business must notify HMRC within 30 days. The business becomes liable to VAT on the first day of the next month.
If VAT registration is not compulsory (as established through the historic and future tests), a business can choose to register for VAT voluntarily. This may allow a trader to reclaim VAT on taxable purchases, which would otherwise need to be absorbed by the business.
Other than those selling to other VAT registered businesses (who can reclaim the VAT that is charged to them); being VAT registered will mean that traders are required to absorb the cost of VAT in order to maintain prices; or pass the cost of VAT on to the consumer at the risk of competitive disadvantage. If your sales are predominantly to other VAT registered businesses, generally it will be better to be VAT registered, even if not compulsory. If your sales are predominantly to consumers, generally we would advise against being VAT registered, unless your supplies are zero rated.
It is compulsory to deregister for VAT if the business ceases to make taxable supplies or the legal status of a trader changes (e.g. a sole trade incorporates).
To voluntarily deregister from VAT, your taxable turnover must be below the VAT deregistration threshold (£83k in 2018/19).
When registration is cancelled, the trader must account for VAT on any assets or stock on hand, if the total VAT due on these exceeds £1,000, and pay this over to HMRC.
A VAT default occurs if a VAT return is received late, or if payment for the full VAT liability has not cleared to HMRC’s account by the due date.
You then enter a 12 month ‘surcharge period’ which extends by a further 12 months for each subsequent default. To get out of a surcharge period, you must submit returns (and pay VAT) on time, for 12 months without any defaults.
The below table sets out the amount of surcharge due, according to the number of defaults. The surcharge is due on the amount of VAT outstanding on the due date, therefore if no payment is due then no surcharge will be payable, although the late submission will extend the default period by 12 months.
|Number of defaults||Annual Turnover < £150,000||Annual Turnover > £150,000|
|First||No Surcharge||No Surcharge|
|Second||No Surcharge||2% (No Surcharge is under £400)|
|Third||2% (No Surcharge is under £400)||5% (No Surcharge is under £400)|
|Fourth||5% (No Surcharge is under £400)||10% or £30 (whichever is more)|
|Fifth||10% or £30 (whichever is more)||15% or £30 (whichever is more)|
|Sixth||15% or £30 (whichever is more)||15% or £30 (whichever is more)|
Under the cash accounting scheme, you account for VAT according to when cash is received from customers or paid to suppliers (instead of using the invoice date).
To qualify, taxable turnover must be less than £1.35m; however, if a business is using the scheme and their turnover exceeds £1.6m then they must stop using it.
The scheme is good for small businesses and start-ups, especially where cashflow is tight. An additional benefit is that bad debt relief is instant, in that, if an invoice is not paid then no output tax is due – saving the need to recover the VAT paid on a bad debt on a future return.
The flat rate scheme was introduced as a means of simplifying the record keeping requirements of small businesses to reduce the administrative burden of collecting and reporting VAT.
Under the Flat Rate Scheme, rather than accounting for VAT on sales and purchases as would happen under normal VAT rules, a fixed ‘flat rate’ percentage is applied to the gross (VAT inclusive) value of sales and paid to HMRC. The percentage is pre-determined by HMRC according to the nature of trade – based on an approximation of taxable costs across a trade to create a ‘VAT neutral’ outcome for traders. On this scheme, VAT cannot be reclaimed on purchases (except certain capital goods, discussed below) and so consideration should be given to this in deciding whether to use the scheme. In practice, the use of this scheme can create a small financial benefit to certain types of business.
In order to use the Flat Rate Scheme, the annual turnover, exclusive of VAT, must be below £150,000 and, should turnover exceed £230,000, including VAT, the trader must leave the scheme.
Common Flat Rate Percentages
|Architect, civil and structural engineer or surveyor||14.5%|
|Computer and IT Consultancy||14.5%|
|Lawyer or Legal Services||14.5%|
If a business is in the first year of VAT registration, traders are entitled to a 1% discount in flat rate percentage until the first anniversary of the VAT registration. Note that this runs from the date of VAT registration, not the date of joining the Flat Rate Scheme.
Expenditure which is capital in nature, for use in the business, but not consumed by it, (i.e. where an asset is purchased) with a VAT-inclusive cost in excess of £2,000 in a single purchase is eligible for VAT to be reclaimed.
Historically, the flat rate scheme was particularly attractive to service businesses with very little taxable costs, an effect which HMRC claim was never intended, and so they introduced a category for ‘Limited Cost Traders’ from 1st April 2017. The flat rate applicable to Limited Cost Traders is 16.5%.
‘Relevant goods’, for this test, are goods used for business purposes, but do not include: