So, you’ve started a small business, and things are going well, but you now realise that you are approaching the turnover rate for Value Added Tax (VAT). It sounds complex, but our accounting team have broken it down into manageable steps so you can get a handle on VAT and keep your business moving forward.
What is VAT?
VAT is a consumption tax levied on the sale of goods and services. As a business owner, you are responsible for charging VAT on your sales and then paying this tax to the government. It is important for small businesses to understand VAT, as non-compliance can result in hefty penalties. While VAT can seem complex, the basic steps involved are straightforward:
Here’s a quick rundown of how VAT works:
Charging VAT: You’ll need to add VAT to the price of your goods or services. The standard VAT rate is usually around 20%, though it can be lower (or even zero) for certain items.
Collecting VAT: Every time you make a sale, you’ll keep track of the VAT you’ve collected.
Reclaiming VAT: You can get back the VAT you’ve paid on your own business expenses, such as materials or services you’ve bought.
Submitting VAT Returns: Every few months (usually quarterly), you report how much VAT you’ve collected from your customers and how much you’ve paid out in business expenses. The difference is either sent to the government, or if you’ve paid more than you collected, you could get an amount of VAT back.
Keeping Records: You will need to hold onto all your invoices, receipts, and VAT returns for a few years. HMRC might want to take a look at your records, so you should keep them for five years.
Who Needs to Register for VAT?
Not all small businesses are required to register for VAT, but the decision is often based on your business’s annual turnover. In the UK, businesses must register for VAT if their taxable turnover exceeds £90,000 in any 12-month period.
Even if your business’s turnover is below the threshold, it may still be beneficial to voluntarily register as this allows businesses to reclaim VAT on their business expenses, providing potential cost savings. A business can claim VAT back from their expenses, but not if they aren’t VAT registered.
Which VAT Scheme is Right for You?
A VAT scheme is a way of paying VAT. There are a few VAT schemes to choose from, and the one you decide on will depend on how you run your business:
- Standard VAT Accounting: This is the default. You add VAT to your invoices and keep track of all your sales and purchases.
- Flat Rate Scheme: Perfect if you want to simplify things. You just pay a fixed percentage of your total turnover, which can be lower than the standard VAT rate. But, you can’t reclaim VAT on most purchases.
- Cash Accounting Scheme: Here you only pay VAT when you actually receive money from customers. This is great for businesses where customers don’t always pay on time.
- Annual Accounting Scheme: This scheme involves less paperwork! You only file one return a year, though you’ll need to make advance payments throughout this time.
Filing VAT Returns and Payments
VAT returns must be filed regularly, typically on a quarterly basis. These returns summarise the VAT you’ve charged on sales (output VAT) and the VAT you’ve paid on business-related expenses (input VAT). The difference between the two amounts is the payment due to HMRC or the refund owed to your business.
Accurate record-keeping is crucial when filing VAT returns, as errors can lead to penalties or delays in receiving refunds. Accounting software can simplify the VAT record-keeping process, helping ensure your compliance and tax accuracy.
VAT Exemptions and Zero-Rating
Did you know that not all goods and services are subject to VAT? Certain items are either VAT-exempt or zero-rated:
- VAT-exempt goods and services: No VAT is charged on sales, but businesses cannot reclaim VAT on related purchases. Common VAT-exempt sectors include some financial services and certain types of healthcare.
- Zero-rated goods and services: While no VAT is charged on sales of zero-rated goods or services, businesses can still reclaim VAT on purchases related to these sales. Examples include some food products, books, and also children’s clothing.
Benefits of VAT Registration for Small Businesses
Even if your business is below, or just below, the mandatory VAT registration threshold, voluntarily registering for VAT may offer you certain advantages:
- Enhanced Credibility: VAT registration can lend credibility to your business, particularly in business-to-business transactions, as VAT-registered entities are often viewed as more established and professional.
- Reclaiming Input VAT: VAT-registered businesses can reclaim VAT paid on business-related purchases, which can reduce overall costs.
- Avoiding Penalties: By registering for VAT and adhering to filing requirements, your business can avoid fines and penalties for non-compliance if your business goes over the required VAT turnover threshold.
Common VAT Challenges for Small Businesses
While VAT compliance is essential, it can present challenges for small businesses, including:
- Cash Flow Management: VAT payments may be due before you receive payment from customers, creating cash flow difficulties. The Cash Accounting Scheme can help alleviate this by allowing you to account for VAT based on actual payments received.
- Administrative Burden: VAT registration increases the need for accurate record-keeping and frequent reporting, which can be time-consuming. Many businesses invest in accounting software or professional services to streamline these processes.
- Compliance Risks: Mistakes in calculating or reporting VAT can result in penalties or HMRC investigations. It’s crucial to stay informed about VAT regulations, which can change frequently, and seek professional advice when needed.
Approaching the VAT threshold, what do I need to do?
VAT may not be the most exciting part of running a business, but it doesn’t have to be scary, either.
Picking the right VAT scheme for your business, keeping good records, and filing your returns on time. If you manage this, then you can focus on growing your business, not stressing over taxes.
It’s always advisable to consult with an accountant to ensure compliance, keep your business running smoothly, and take full advantage of any potential VAT benefits. Contact our accounting team for advice if you are approaching the VAT threshold.
