The 101 of Value Added Tax (VAT)

For small business owners the thought of VAT can be completely overwhelming, but with the correct information and professional tax planning advice it can be easy and straightforward to deal with.

WHAT IS VAT?

Value Added Tax (VAT) is a consumption tax levied on the sale of goods or services provided by UK businesses.

VAT is collected on behalf of HM Revenue & Customs by companies. A company pays VAT to HMRC by calculating the amount of VAT charged to customers less any VAT they have paid on their own business purchases.

Information is presented to HMRC via a quarterly VAT return.

All goods and services are either VAT-rated, Zero-rated or VAT-exempt.

HISTORY OF VAT

In the UK VAT came into force in 1973 when it was required as part of the conditions of us joining the European Economic Community. It replaced Purchase Tax, which had been charged on the manufacturing process rather than at the point of sale and had been in place since 1940.

At the beginning it was a standard 10% rate on most goods and services. In the 45 years since then, the rates at which it is charged, and the rules for which products it is charged on, have become complex and rates have changed many times.

  • 1974 – Standard rate reduced to 8% while some luxury goods were increased to 12.5%.
  • 1979 – Standard rate was almost doubled to 15% and the higher rate was abolished
  • 1991 – the rate of VAT was raised to 17.5%
  • 1997-2007 Organisational changes with some products only charged 5%
  • 2011 – VAT went up to 20%

VAT is considered an efficient and effective tax for governments to collect. It has now been adopted by over 130 countries all over the world and is under consideration in America.  Here in the UK the revenue raised in the fiscal year 2017/2018 was in the region of £124.5 billion. This makes it the third largest tax in the UK, after Income Tax and National Insurance

CURRENT RATES AND RULES

Standard rate – 20%

Most goods and services are standard rate. You should charge this rate unless the goods or services are classed as reduced or zero-rated.

Reduced rate – 5%

When you charge this rate can depend on what the item is as well as the circumstances of the sale, for example:

  • children’s car seats and domestic fuel or power are always charged at 5%
  • mobility aids for older people are only charged at 5% if they’re for someone over 60 and the goods are installed in their home

Zero rate

Zero-rated means that the goods are still subject to VAT but charge at a rate of 0%. You must record them in your VAT accounts and report them on your VAT Return.

Examples include:

  • books and newspapers
  • children’s clothes and shoes
  • motorcycle helmets

These rules and rates can change at any time, so it is essential that you ensure you are fully informed as it is your responsibility to charge and reclaim VAT correctly. If in doubt, always get advice from a qualified tax consultant.

SHOULD I BE REGISTERED FOR VAT

Currently all businesses in the UK which provide taxable goods and/or services with a taxable turnover of £85,000 must register to pay VAT.

Small businesses with a lower turnover, but who wish to reclaim VAT that they pay on products and/or services they use in their business can voluntarily register for VAT.

You may wish to consider the nature of your business before making the decision to register.  If you mainly sell to the public, it may mean that you increase your prices and lose customers. However, if you sell mainly to businesses, they will be happy to be able to reclaim on their own returns.

Currently there are 2.67 million businesses registered for VAT in the UK.

HOW DO I REGISTER

Apply for a VAT registration certificate by creating a VAT online account, also known as a Government Gateway Account.  You will need to supply details about your business’ turnover, activity and your bank details. Your VAT registration certificate will be sent to you within 14 days with your VAT number and details of when to submit your first VAT return, how to make payments and your “effective date of registration”.

COMPLETING VAT RETURNS

VAT returns are completed every 3 months (the accounting period). You are required to maintain well-organised business records so that you can complete your VAT returns accurately. Your total sales/purchases, the amount of VAT that you owe and the amount you can reclaim (for goods and services bought in order to operate your own business). Once you have registered for VAT you are required to submit your return even if there is no VAT to pay or to reclaim.

You can submit your VAT returns online using your 9-digit VAT number and your VAT online account. There is guidance available throughout the process to help you complete the return correctly. You can also nominate a representative, such as your accountant, to submit your return on your behalf.

MAKING VAT PAYMENTS AND DEADLINES

Payments and refunds are taken from or paid directly into the bank account you specified when you registered.

The deadlines for payments are 1 calendar month and 7 days after the end of your accounting period. However, if you are not paying by direct debit you must allow time for your payment to reach HMRC.

Refunds will be received within 30 days of you submitting your return.

If you are late submitting your VAT return, you will enter a 12-month ‘surcharge period’. Although you don’t pay a surcharge for your first default, you will have to pay a surcharge on successive defaults. The amount depends on how many times you default in this period and the annual turnover of your company. Surcharges are usually calculated as a percentage rate on the outstanding VAT you owe. The rate increases if you default more than once.

You will not pay a surcharge if you submit your VAT return late but still pay any VAT due on time, if you have no VAT to pay or a VAT refund is due.

ALTERNATIVE VAT SCHEMES

Registering for VAT brings with it a lot of additional administration which may overload smaller businesses. There are three alternative VAT accounting schemes available that are designed to help with this problem.

THE FLAT RATE VAT SCHEME

To be eligible for this scheme, businesses must have sales of under £150,000 (excluding VAT)

THE CASH ACCOUNTING SCHEME FOR VAT PAYMENTS

To be eligible for this scheme, a business must have a VAT taxable turnover of no more than £1.35 million.

THE VAT ANNUAL ACCOUNTING SCHEME

To be eligible for this scheme, a business must be VAT-registered, with an established turnover of £1.35 million.

For more information about these schemes, and whether they can benefit your small business, contact us for an no obligation, no cost to you, consultation.

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