How does VAT Work for Small Businesses in the UK?

VAT for small businesses

Small businesses in the UK may feel overwhelmed by the complexities of Value Added Tax (VAT). But, understanding VAT is essential if you want to stay compliant with HMRC regulations and ensure your business is profitable.

In this blog post, I will explain everything you need to know about VAT so that you are up-to-date on the rules and ensure compliance. From tax rates to registration thresholds, find out all the key facts, so your business benefits from complying with relevant laws.

What is Value-Added Tax (VAT)?

Value-added tax is a taxation that businesses must add to their sales if registered. VAT is collected by businesses from customers and then paid directly to HMRC. We all pay VAT on goods and services we purchase, but sometimes you do not realise that you are being charged for it as it becomes part of the price.

VAT is a consumption tax, which is a tax based on how much goods or services you consume. The more you consume, the more you will pay.

How does VAT work for small businesses in the UK?

Value Added Tax (VAT) is something that small businesses need to think about. It is a tax that people have to pay when they buy most goods and services. VAT is calculated as a percentage of the overall sale price and must be collected and paid to the government.

Businesses that make sales and are over the VAT threshold must register with HMRC and charge VAT on goods or services they sell. At the same time, any registered business that pays out for goods/services reclaims the VAT on purchases on their VAT return.

Knowing how VAT works for small businesses can help ensure your business complies with taxes, giving you peace of mind when running your business.

How can small businesses claim back VAT they’ve paid on business expenses?

VAT-registered businesses reclaim VAT by completing a quarterly VAT return. This means businesses pay the net balance of VAT due or repay any overpaid VAT.

When claiming back VAT, businesses must keep all receipts and invoices for six years for audit purposes. HMRC can conduct a tax audit anytime, so maintaining good records is essential.

If you are a startup on your first VAT return, you can reclaim VAT on business expenses incurred up to four years before registering for VAT. It includes reclaiming services like legal fees to get the business running and capital expenses, including computers and other equipment.

The benefits of registering for VAT

Registering for value-added tax (VAT) is a great way to stay compliant with the applicable laws in your country or region. By registering for VAT, you can reclaim the amount of input VAT on most business expenses, such as materials and services. For some businesses, if you have made a large purchase, for example, new equipment or stock, you might be due a refund.

Some businesses will only deal with VAT-registered companies, allowing them to reclaim the VAT on the purchases of goods and services.

Disadvantages of Being VAT Registered

Although if you have reached the VAT threshold, you must register for VAT, there are also times when you can register voluntarily. Voluntary VAT registration might seem like a good idea, but there are some disadvantages.

  • Administration – As a VAT-registered business, you must complete quarterly VAT returns and keep up-to-date records of all transactions.
  • Higher Prices – If you are registered for VAT, you must charge it on all taxable sales and services. This can make your products or services more expensive, which could put customers off.
  • Cash Flow – When you are registered for VAT, you must pay the amount of tax collected to HMRC within 1 calendar month and 7 days. You must therefore ensure that the money is available.

What is the VAT Threshold?

If you’re a business owner in the UK, it’s essential to be aware of the VAT threshold so that you register on time. The VAT threshold is £85,000, and it applies if, by the end of any month, your total VAT taxable turnover for the last 12 months was over this amount. You must register within 30 days of the month that you go over the threshold.

If the business exceeds the threshold temporarily, it is possible to request an exemption from HMRC. You must write to HMRC with evidence showing that you do not expect to go over the deregistration threshold of £83,000 in the next 2 months.

Failing to register when your profits reach this threshold could mean paying hefty fines or penalties.

How to register for VAT

For businesses with VATable turnover, to register, you’ll need a Government Gateway user ID and password, and you can usually do it online within minutes. Upon registering, you’ll also get access to your VAT online account.

Alternatively, you may appoint an agent to submit VAT returns and other dealings with HMRC on your behalf. If you use an agent, you can still register for an online account after receiving the VAT number.

When you are registered for VAT, you will receive a VAT registration certificate and details of when the business is registered from and when you need to start charging VAT on your goods and services. The VAT certificate includes the VAT registration number.

VAT and Making Tax Digital

Joining the rest of Europe, HMRC’s Making Tax Digital (MTD) program was introduced to help make tax returns easier for UK business owners. As such, MTD requires VAT returns to be electronically submitted via accounting software compatible with the program.

UK VAT Rates Explained

VAT rates are divided into four categories: standard, reduced, 0% and exempt.

Standard Rate20%Charged on most goods and services within the UK
Reduced Rate5%Includes items such as utilities, car seats for children or certain energy-saving materials.
Zero Rate0%These are items that the Government charges VAT on, but it is set to 0%. It includes basic foods, children’s clothing and books
VAT ExemptSome goods and services, such as stamps, betting and health-related products, are exempt.

It’s worth taking the time to understand which VAT rate applies to what you’re buying or selling. That way, you can ensure you meet all the necessary obligations regarding VAT tax rates in the UK. A complete list of VAT rates is on the HMRC website.

VAT Calculation Example

There is a simple formula that you can follow for each VAT rate. You multiply the VAT exclusive price by 1 + the VAT rate divided by 100. Below are the simple formula and examples using 200.

20% Multiply by 1.2 = 240

5% Multiply by 1.05 = 210

If you remember this formula, it is much easier to calculate the VAT-inclusive price.

What are the UK VAT Schemes

Different VAT schemes are available depending on the size and type of business in question. Below is a brief description of each scheme:

Standard Accounting Scheme

The main scheme is for standard VAT for larger businesses. The VAT is calculated when you invoice someone or receive a bill from a supplier.

Flat Rate VAT Scheme

Small businesses can simplify their VAT affairs by opting for the flat rate scheme – wherein a preset percentage is applied to all income regardless of expenditure outlay. Each business pays a fixed rate of VAT, depending on the type of business. You still charge VAT at the standard rate on all the goods and services provided.

Cash Accounting Scheme

The cash accounting scheme allows businesses to pay VAT on goods or services when they receive payment from customers and claim it back when they pay their suppliers. This scheme is suitable for businesses with lower turnover.

Annual Accounting Scheme

The annual accounting scheme is for businesses with a turnover below £1.35 million. You submit one VAT return yearly rather than four and make payments in advance.

Marginal Scheme

The marginal scheme lets you calculate the VAT on the value you added to goods you resell. This scheme is mainly for second-hand goods, antiques and collector items.

Record keeping and submitting returns for VAT registered Businesses

Accurate record-keeping is one of the most critical tasks for any VAT-registered business. This means keeping detailed records of all transactions that are subject to VAT. This includes all invoices and receipts for all goods and services. The best way to keep accurate records is by using accounting software or engaging an accountant’s services.

These records must be kept for at least six years if HMRC requests them for inspection or an investigation into your business.

A VAT return must be submitted every three months by any business that is registered for VAT (unless you are on the annual scheme). The return is submitted via accounting software or bridging software; all VAT returns are now completed electronically.

VAT returns are due 1 month and seven days after the VAT quarter. For example, your VAT period is from 1st January to 31st March, and your return is due on 7th May.

What information must I include in a VAT invoice?

For VAT-registered companies, specific details must be included on the invoices.

You should include the following:

  • A unique invoice number that will identify the document
  • The date of supply
  • Date of issue for the document if different to the date of supply
  • Your business name, address and VAT registration number
  • The customer’s name and address
  • A full description of the goods or services provided, quantity, unit price and VAT rate
  • The total amount charged for the goods/services, including any discounts given
  • The total amount of VAT charged
  • Gross amount of the invoice
  • The reason for any zero or VAT-exempt items

To ensure that an invoice shows all of this information, it is recommended to use accounting software. HMRC have a complete list available.

VAT Direct Debit

If you want peace of mind that your VAT bill will be paid on time, it is possible to set up a direct debit. To ensure payment is taken, it must be set up 3 working days before you submit the VAT return online.

The direct debit will be taken 3 working days after the payment deadline or, if it is filed late 3 days after the return is filed.

Common mistakes made by small businesses with VAT

Some of the most common mistakes for VAT are:

  • Not registering for VAT when the requirement to do so arises
  • Charging customers the wrong rate of VAT or not charging any at all
  • Not being able to account for all of the VAT charged and paid
  • Not keeping accurate records
  • Late submission of returns
  • Late VAT payments

What is the Difference between VAT Exempt and Zero Rate VAT

VAT-exempt items are those goods and services that are not subject to any rate of VAT. This includes some healthcare services and educational fees.

Zero-rate VAT is applied to certain items that would usually have VAT, but it is set to zero. This includes children’s car seats and books.

VAT Penalties

Missing a VAT return or payment deadline can be stressful, especially if it is a busy time for the business.

If you’re late in sending your return, you will start a 12-month surcharge period. There is nothing to pay for the first late return, but you may have to pay a surcharge on other late returns.

Late VAT payments may also be charged interest. HMRC will let you know how much you need to pay in surcharges and VAT.

VAT FAQ

What is Input Tax?

Input tax is the amount of VAT that a business has paid to its suppliers on purchases. This can then be claimed back from HMRC when your business submits a VAT return.

What is Output Tax?

Output tax is the amount of VAT that is charged to customers when goods and services are sold. This is collected by the business and then passed to HMRC when a VAT return is submitted.

What is the tax period?

The tax period is the length of time between two successive VAT returns and can be up to one year; most businesses have a 3-month tax period.

Can I claim a tax refund?

Yes, if your business is VAT registered and you have paid more than you received in the same period, you can claim a tax refund.

How does VAT work? Conclusion

In order to ensure accuracy in your tax reporting and to stay compliant with HMRC regulations, it is important to understand the basics of VAT.

This includes understanding when to register for VAT, what goods and services are subject to VAT, the different rates that can apply, and what information must be included on invoices. It is also advisable to familiarise yourself with common mistakes businesses make regarding VAT and how to set up a direct debit for payment.

Finally, for any VAT-registered company, always consult an accountant or professional if you have any questions about your business’s VAT obligations.