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VAT basics

Registration – compulsory or voluntary

Is it worth registering for VAT voluntarily?

Claiming VAT on assets at registration

Basic Vat Accounting or Flat Rate Scheme

Low Cost Traders and Flat Rate

Standard Rated, Zero Rated and Exempt Supplies

Output Tax and Input Tax

Return cycles, payment and penalties

Online filing requirements

VAT interaction with other EC states

Other VAT content

Registration – compulsory or voluntary

If the company turnover (i.e. gross income) is less than £85,000 (2019-20 figures) then registration is optional, over £85,000 it is compulsory. Once registered you add VAT at 20% onto the invoices you send your client/agency, and claim VAT back on allowable expenses. The difference is paid to HMRC at the end of the quarter.

The registration thresholds work on a rolling 12 months basis, not necessarily a quarter, financial year or tax year. Unregistered businesses need to look at their turnover at the end of each month, and if for the last 12 months (or from date of starting to trade if less than 12 months) it is more than £85,000 the registration must be effected from the second successive month.

Example:

Turnover 12 months 1 February to 31 January – £55,000

Turnover 12 months 1 March to 28 February – £58,000

Turnover 12 months 1 April to 31 March – £69,000

Turnover 12 months 1 May to 30 April – £86,000

The registration threshold has been breached at 30 April. Registration must be effected from 1 June. From 1 June VAT must be charged on all invoices raised.

All new VAT registration applications must be made online. The paper form VAT1 has been abolished.

Is it worth registering for VAT voluntarily?

A frequent question is whether its worth registering for VAT voluntarily if you are under the VAT threshold?

Generally this depends on your customer profile and the nature of your supplies:

  • standard rated and mainly consumers (B2C) – delay registering as long as possible: your customers can’t recover VAT so its a real cost, either explicitly to them or born by you on your turnover
  • zero rated and mainly consumers (B2C) – probably worth registering ASAP for the benefit of input tax deduction
  • mainly business customers (B2B) – probably worth registering ASAP regardless of whether supplies are zero rated or standard rated for the benefit of input tax deduction.  Some businesses, eg banks, NHS, education, may not be able to recover VAT but generally they are used to seeing it charged to them and factor the cost of irrecoverable VAT into their margins – however if you have a number of small clients in this sector, it may be worth thinking about this in more detail
  • exempt supplies – you probably can’t register

If you trade abroad you may need to take specialist advice as rules differ according to whether you are supplying goods or services, to consumers or businesses, and EU or non EU.

Claiming VAT on assets at registration

When you register for VAT you can go back and claim VAT input tax as follows:

  • 4 years for goods you still have, or that were used to make other goods you still have – this includes both (a) stock purchased and in hand and (b) assets such as fixtures and equipment.  But you can’t claim for stock already sold or assets scrapped
  • 6 months for services

NB there is sometimes confusion around assets and services.  Building materials you bought would be an asset and subject to 4 years recovery, materials a builder supplied as part of a construction project would be part of a service and subject to 6 months recovery.  The same principle could apply elsewhere, eg software, design.

Basic Vat Accounting or Flat Rate Scheme

There are two main ways to deal with your vat.

First there is the traditional basic vat accounting method. Under this method vat is accounted for at 20% on all sales invoices, and claimed back on all relevant expenses.

Example for a contractor/PSC:

Supposing your weekly invoice is £1,000 to your agency. You are registered for VAT so you invoice them £1,000 net + £200 VAT = £1,200.

If your invoice is the same each week of the quarter then you will have collected VAT of £2,600 (i.e. £200 x 13) and this is due to be paid to HMRC no later than 30 days after the quarter end, via an online VAT return.

When paying HMRC you can deduct VAT incurred on expenses. EG if your expenses were £2,400 including VAT (equates to £2,000 plus £400 VAT) then you deduct the £400 and pay HMRC £2,200 (£2,600 less £400).

In terms of Corporation Tax, the company’s taxable income for the quarter is £13,000 and its expenses £2,000 – i.e. excluding the VAT element.

The alternative is the Flat Rate Scheme (FRS). If your vat exclusive turnover is less than £150,000 then you can use this scheme. Vat is still charged at 20% on invoices, but you pay a lower percentage of the sales income to HMRC and claim no vat back on expenses.

The main flat rate percentages which may apply are:

  • Any other activity not listed elsewhere – 12.00%
  • Business services not listed elsewhere – 12.00%
  • Computer repair services – 10.50%
  • Financial services – 13.50%
  • Management consultancy – 14.00%
  • Computer and IT consultancy or data processing – 14.50%

Businesses are entitled to a 1% reduction in these rates for their first year of operation.

These amounts apply to gross income. The normal 20% is applied to net income. On a like for like basis 20% on net income equates to 16.67%

From April 2017 a new 16.5% applies for business which are deemed “low cost traders”, seemingly defined as purchases of goods for business use – not equipment or services – of less than £1,000 a year.  The clear intention is to move most PSCs and other labour only businesses out of the FRS as its considered “abusive”.   The 16.5% rate negates almost all the benefit of flat rate scheme.  See Low Cost Traders and Flat Rate

You can join the Flat Rate Scheme if you anticipate vat exclusive turnover of less than £150,000 in the next year, but must leave the scheme if your vat inclusive income exceeds £230,000; businesses on Flat Rate must carry out an annual check of their turnover against this limit.  Slightly different rules apply if you have a mixture of vatable and non vatable income, check with us for details.

If you are unsure what rate applies to your business it is suggested that you contact HMRC National Advice Service on 0845 010 9000.

Further information on the scheme is in notice 733 on HMRC web site

A full list of percentages from HMRC web site

Example

Supposing your weekly invoice is £1,000 to your agency. You are registered for VAT so you invoice them £1,000 net + £200 VAT = £1,200.

Your flat rate percentage is 14%

If your invoice is the same each week of the quarter then you will have collected VAT of £2,600 (i.e. £200 x 13). Your gross income during the quarter is £15,600.

At the end of the quarter you pay HMRC £15,600 x 14% = £2,184, with no deduction for expenses (unless you have capital expenditure over £2,000 including vat, in which case the vat on these items an be deducted in addition).

In terms of Corporation Tax, the company’s taxable income for the quarter is £13,416, i.e. gross income less vat. Expenses are claimed in the accounts on a gross basis as normal.

Be aware that flat rate turnover includes some items not normally subject to vat, eg rents = this is normally more of a issue for partnerships and sole traders than small companies, but anyone joining FRS should be aware of the risks if they have mixed income.

Here is a worked example:

Low Cost Traders and VAT Flat Rate

From April 2017 the Flat Rate Scheme is restricted for “low cost traders”.

Under the new rules, businesses that fall into this definition will be obliged to apply a FRS rate of 16.5% instead of their normal sector rate, and many businesses, in particular contractors/PSCs, will no longer find it economical to use.

For a business to be able to continue using their normal trade sector FRS they will be required to evidence that expenditure on “goods” is a) at least 2% of its turnover, and b) at least £1,000 per year, these calculations being performed for each return (with £1,000 pro rated). This means that, at the end of every period, before the FRS percentage can be determined, you must work out whether the expenditure on goods has been at least 2% of the VAT inclusive invoiced sales in that period, and if so, that the expenditure on goods is at least £250 (£1,000 /4). If both tests cannot be satisfied, the 16.5% rate must be used for that period.

By “goods” this means tangible purchases such as materials and other items that are resold to clients/customers, or actually used up by the business. The following cannot be treated as goods :

  • Rent and other establishment costs
  • Capital items e.g. computer and office equipment
  • Software costs
  • Telephone/Broadband/Postage/Advertising
  • Motor/travelling/subsistence costs
  • Sub contractor costs

Stationery costs can be treated as goods, as can non capital computer peripherals, but only insofar as they are either sold on for a profit, or actually used by the business. HMRC will be on the look out for artificial purchasing arrangements, for example businesses purchasing excessive amounts of stationery just for the purpose of inflating the cost of goods. Goods cannot be given away, donated to charity, or retained for personal use.

Standard Rated, Zero Rated and Exempt Supplies

These are the three main types of vat liability attaching to goods and services.

  • Standard rated – means the goods or services attract standard VAT (currently 20%)
  • Zero rated – means goods and services are charged at 0% VAT.  This means there is no VAT due on the supply, but the supply counts as VATable turnover so the business can VAT register and recover Input Tax.
  • Exempt – this means the supplies are outside the scope of VAT – no VAT is chargeable on them, but equally they don’t count as VATable turnover for recovering Input Tax.

There are also reduced VAT rates (currently 5%) on certain supplies, eg of domestic fuel and renovation of empty houses.

HMRC have a guide on VAT rates and sectors: http://www.hmrc.gov.uk/vat/forms-rates/rates/goods-services.htm

Output Tax and Input Tax

You’ll hear these terms a lot.

Output Tax is what you charge to others on your sales when VAT registered, be they supplies to businesses or consumers.  Output Tax may be explicit, eg if you charge a customer £1,000+vat, or may be hidden, eg if you own a shop and retail goods with VAT inclusive prices.

Input Tax is VAT charged to you by your suppliers.  If you are VAT registered and use standard VAT then you offset this against Output Tax on your quarterly return.  If Input Tax cannot be recovered for any reason, eg purchase of cars, or if you are not VAT registered, then it is “sticky Input Tax”

Return cycles, payment and penalties

VAT returns and payments are due on a quarterly basis, and HMRC allow 1 month and 1 week from the quarter end date to file and pay. There is an onerous penalty regime for late VAT returns and payments, so we advise clients to stay on top of VAT matters at all times.

Online filing requirements

It is now compulsory for all VAT registered businesses to file VAT returns online, and from April 2017 under Making Tax Digital this must be via software, either an accounts package, eg FreeAgent, or Bridging Software

VAT interaction with other EC states

Businesses that sell their services to customers in other EC states are required to file a EC Sales list. If you believe your business falls into this category, and you need guidance on this, please request our guidance notes covering this.

The above will change depending on the terms of Brexit.

Other VAT content

HMRC publish a number of VAT guides on the GOV.UK website.  See the full list

There are other VAT news stories and comment on our site: see them all here