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A question from a client:

I have a question about the VAT registration. I’m struggling to remember why I thought I should register, and talking to others they say its’ a bad thing to be registered. I’m wondering if I’ve done the right thing. I don’t ever expect to exceed the threshold that requires registration.

Answer:

There is no right and wrong answer to this – currently VAT registration is optional on turnovers up to £75,000, however if you are working business to business you are almost certainly likely to be better off being VAT registered, albeit at the expense of some extra admin in terms of filing the quarterly VAT returns.

When you are VAT registered your charge your customers 20% on top of your normal invoices, which you collect from your customers and pay to HMRC quarterly – this is called Output Tax.  When paying Output Tax over you deduct any VAT you’ve incurred, eg accounting costs, IT costs, subsistence – known as Input Tax – thus you are better off to this extent as otherwise you would have to bear the cost of that VAT Input Tax.

Your customers, if they are businesses, will simply offset the VAT you charge them against their own VAT, so they are no worse off.

NB 1 – if for any reason your customer isn’t VAT registered then the VAT you charge them will be a real expense to them, and may make you less attractive as a supplier, but this is a rare circumstance (eg contracting with the public sector, medical professionals or similar).

NB 2 -for retail businesses the converse applies – as your customers cannot recover VAT its best to defer registration as long  as possible – either you need to add VAT to your prices, making you more expensive compared to competitors, or you need to absorb the VAT yourself making you less profitable.

Traditional VAT works by your adding 20% on to your invoices, collecting this, and paying it over the HMRC quarterly with a VAT return after deducting VAT on eligible expenses – as described above.

Example quarter suppose you invoice £3,000 a month – received x £3,000 + vat £600 on each – received £1,800 VAT.  VAT on expenses, say £100 (Accountancy fee, IT costs, mobile phone, stationary) – pay over £1,700. You are £100 better off, i.e. recovered vat on expenses.

However where the real savings come for smaller simple businesses, eg service companies, is with the Flat Rate VAT scheme.

Flat rate works differently – you still add 20% to your invoices, so using the previous example you receive £1,800 vat.  However a flat rate percentages is applied to gross income – the percentages vary by sector:

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%

There is a 1% discount in your first year of VAT registration so you need to adjust the % used if it applies.

Suppose  that the 12% “business services not listed elsewhere” applies, the example now becomes:

Example quarter using above figures  – received x £3,000 + vat £600 on each – received £10,800 total, at 12% pay over £1,296 against £1,800 received.  You are better off by £504 for the quarter.

Obviously the savings are less on a lower percentage band, and vary according to income.

Generally, unless there is clear abuse, HMRC don’t challenge the selection of flat rate bands