Well, what exactly is VAT?
Without getting too technical, VAT or ‘Value Added Tax’ is a tax on spending on goods and services. Unfortunately, it’s not the quantity of wine in your VAT, sitting next to you when you start to tackle this article! It’s not that bad, promise.
It’s the 3rd largest source of income for the government after income tax and national insurance and is collected from businesses. So when you, as a consumer, buy something in a shop, you will be paying the retail price plus VAT. The shop will then hand over that VAT portion to the government.
The rate of tax is currently 20% in the UK and is levied on nearly all transactions with the exception of items such as domestic fuel and power which has a reduced rate of 5% and newspapers, books, childrens’ clothing and most food which have a 0% rate.
How does it affect my business?
Well when your business turnover exceeds £85,000 (the threshold in the UK set for year 2017-18) in the previous 12 months, or will do so in the next 30 days, you are required to register with HMRC and start charging your customers VAT.
You will also be able to offset the VAT on Sales (called Output Tax) by VAT you are charged by your suppliers (called Input Tax) and will only have to hand over the net of these two amounts to the taxman.
If at times the VAT charged by your suppliers exceeds what your have invoiced to your customers you will be refunded the difference - this can often happen if you are a start-up incurring costs before you can start charging your customers or where your invoicing to your customers is on an infrequent basis.
Is there an awful lot of paperwork?
- On a quarterly basis you will need to submit a VAT Return online to HMRC in the UK showing the amount of Output and Input Tax invoiced in that quarter and pay over the net amount to HMRC. You are given approximately a month after the quarter end to complete the form and pay the tax.
- You will need to keep good accounting records so that you can submit the VAT Return correctly and there are very specific rules you have to follow as to the information included on your sales invoices.
- There are several schemes available for small businesses to make compliance easier including a Flat Rate Scheme, a Cash Accounting Scheme and special schemes are available to retailers.
- VAT on entertaining costs cannot be reclaimed, but VAT on bad debts where your sales invoice had not been paid can be reclaimed.
- Your VAT Return may be subject to an audit by HMRC so good accounting records are essential. This does happen - they do turn up.
- Late or inaccurate submission of your VAT Return may incur penalties.
So if my turnover is under £85,000, I have nothing to worry about?
That’s correct, but remember all the costs you incur in your business probably have VAT charged on them which you cannot recover. But, there is nothing to stop you registering voluntarily before you reach the £85,000 threshold so you can reclaim the VAT on your costs, but remember you will also be required to charge VAT on your Sales.
If your sales are to VAT registered businesses this may be a good idea as they can recover the VAT, but if your customers are mainly small and not VAT registered this will increase the cost to them by the additional VAT that you charge them. For example:
Business A charges Business B £1000 for a product.
Neither business is VAT Registered.
Then Business A’s turnover becomes over £85,000 pa and he now has to become VAT registered and charge VAT to his customers.
Business B is a smaller business and is not yet required to become VAT registered, Business B orders the same £1000 product again, but it will now cost £1,200 (£1000 + 20% VAT).
Business B has now seen a 20% increase in his costs as he will not be able to claim that VAT back as he is not VAT registered.
This can become an issue for small businesses, who have to absorb this additional cost. Do remember though as mentioned, you can register to claim that VAT back, before you hit the threshold, but you’ll need to charge VAT on your products. It might be that your product, could go up by 20% and due to it’s uniqueness, you can get away with this.
Talk to your accountant if this is an issue.
- There are plenty of good online accounting software companies which will help you produce an accurate VAT Return - for example www.xero.com/uk, www.sage.co.uk, www.quick books.co.uk.
- Talk to your accountant about whether any of the special VAT schemes would be appropriate to use for your business.
- Try to meet the quarterly submission deadlines so as not to get a bad name with HMRC!
- Reward yourself at all points, paperwork needs help. But, remember to try and not drink the whole VAT of wine whilst dealing with the numbers of your business - it never ends well. Well, actually it can end well, but then in the morning you realise, well you realise not to drink whilst dealing with finances!