VAT

The Government introduced VAT in 1973 to generate additional revenue. It is collected by HM Revenue and Customs (HMRC).

VAT applies to all 'taxable supplies' VAT including the sale of goods and services. VAT is added to everything a business sells (if the business is registered for VAT). This is known as ‘Output VAT’.

Concurrently when a business buys goods or services from other businesses, VAT can be claimed back from the purchase total. This is known as ‘Input VAT’.

The amount of tax paid to the Government is the Output VAT minus the Input VAT.

From 1 April 2024, the VAT registration threshold is £90,000. If annual business turnover exceeds this threshold then a business has to register for VAT (large penalties apply for failure to do so). If annual business turnover is under the threshold, then it is not mandatory to register. However, it is then obvious that business turnover is less than £90,000, which you may not wish to advertise.

You can register for VAT online on the Government website. Under certain circumstances, you may register by post using form VAT1. These circumstances include where:

• you want to apply for a ‘registration exception’

• you’re registering the divisions of business units of a body corporate under separate VAT numbers

• you’re joining the agricultural flat rate scheme

For more information, read VAT registration.

There are 3 alternative schemes suited to small businesses, each with its own pros and cons.

The flat rate scheme

A business pays a fixed rate of VAT to HMRC and keeps the difference between what the customer is charged and what is paid to HMRC. For example, an IT consultant’s flat rate is 14.5%, they charge the customer 20% VAT, and keep 5.5%. Different types of businesses pay different rates. These rates are listed on the Government website. VAT payments are calculated as a fixed percentage of your total turnover. In this scheme, VAT cannot be reclaimed on purchases - except for certain capital assets over £2,000. To join the scheme VAT turnover must be £150,000 or less (excluding VAT), and you must apply to HMRC.

For more information, read VAT Flat Rate Scheme.

Cash accounting scheme

VAT returns are based on when money for purchases or sales physically changes hands, not the date stated on invoices. This is a good scheme if you use cash accounting. Otherwise, you risk paying VAT on sales you’ve not yet been paid for (as is the case with the flat rate scheme).

Under this scheme you:

• pay VAT on sales once your customers pay you

• reclaim VAT on your purchases once you have paid your supplier

Note that to be eligible for this scheme, you need a maximum annual turnover of £1.35 million.

For more information, read VAT Cash Accounting Scheme.

Annual accounting scheme

You do one VAT return a year, whereas with the other two schemes you do so once a quarter (ie you submit your VAT Returns and payments to HMRC 4 times per year). Based on the figures in this annual return, you then make advanced monthly payments in the following year. These start in month 4 and continue until month 12, a total of 9 payments. There is a balancing payment in month 14.

If you’re able to sync your annual VAT return with your financial year, you’ll avoid additional paperwork too. And spreading the payments out will help with budgeting and financial forecasting. To be eligible for the scheme you need a maximum annual turnover of £1.35 million.

For more information, read VAT Annual Accounting Scheme.

When a business is VAT registered, it is normally required to add VAT when invoicing a client for services and keep a record of the VAT charge to be added to VAT returns.

Prices

When a business is VAT registered, it is normally required to add VAT when invoicing a client for services and keep a record of the VAT charge to be added to VAT returns.

Prices

Prices can be inclusive or exclusive of VAT.

When charging VAT on goods or services you need to make a calculation. This also applied when you’re working out the amount of VAT you can reclaim on items you sold inclusive of VAT.

VAT-inclusive 

When you are working out a price inclusive of the standard VAT rate (20%), multiply the price exclusive of VAT by 1.2.

VAT-exclusive

When you are working out a price exclusive of the standard VAT rate (20%), divide the price including VAT by 1.2.

From 1 April 2022, all VAT registered businesses must follow the Making Tax Digital rules by keeping certain digital records (eg VAT registration number, the VAT scheme used and the VAT rate charged on goods and/or services) using compatible software. 

The Making Tax Digital rules don’t apply if:

• a business uses the VAT GIANT service (eg Government departments or NHS Trusts)

• an exemption applies (eg the business is subject to an insolvency procedure)

Businesses below the VAT threshold can voluntarily join the Making Tax Digital service. 

For more information, see the Government's guidance.

You can reclaim VAT paid on goods and services purchased for use in your business.

You are in business when, for example, you earn an income by carrying on a trade, vocation or profession - by being self-employed or through another entity, such as a limited company.

If you carry on a trade, for example, you receive money for appearing on a television programme, you provide a service to a customer (in this case, the television production company) for a reward. Any VAT on monies received from the customer can be reclaimed.

For more information, read Reclaiming VAT.