VAT’s short for Value Added Tax, and it’s a tax that’s charged on most sales of goods and services in the UK.
Sales on which VAT would normally be charged are called “taxable sales”. Sales that are exempt from VAT, or outside the scope of UK VAT, are not taxable sales.
Debunking the VAT myths
There are quite a lot of myths surrounding VAT.
Firstly, when you make sales, you won’t charge VAT unless you’re registered with HM Revenue & Customs (HMRC) to do so. This is usually known as “registering for VAT”.
Only businesses can register for VAT, not members of the public.
And not all businesses have to register for VAT. You only have to register your business if its annual taxable sales are over the limit set by HMRC, currently £77,000.
VAT charged and reclaimed
If your business is registered for VAT, then it has to charge VAT on all the taxable sales it makes to its customers. This is important, because there’s another myth that you only have to charge VAT to customers who are themselves registered. That’s unfortunately not true, you would have to charge VAT on all your taxable sales.
The VAT you charge to your customers is called “output VAT”.
Your business will also be able to reclaim some of the VAT that its suppliers charge. I say “some” advisedly, because there are some supplies on which VAT can’t be reclaimed, such as entertaining anyone other than staff. VAT that can be reclaimed is called “input VAT”.
VAT-registered businesses must file a regular report called a VAT return to HMRC. The VAT return shows the business’s output VAT, less its input VAT. The difference is what the business must actually pay to HMRC.
We’ll look more at completing VAT returns in a later article in this series.
When a business must register for VAT
You can choose to register your business for VAT before its taxable sales reach £77,000 a year, unless you’re only making sales that are exempt from VAT or outside the scope of VAT. In that case you would never register for VAT.
Registering before you have to is called “voluntary registration”, and can help your cashflow, because being registered for VAT allows your business to claim back input VAT on its costs.
However, in some cases it’s not a good idea to register for VAT voluntarily, aside from the extra administrative burden.
The key to identifying whether or not your business should register early is to look at who its customers are.
If your business’s customers are other businesses who are likely to be registered for VAT, then they will be able to reclaim the VAT that you charge them, so you can go ahead and register as soon as you want to.
But if your business’s customers are the general public, or small businesses who may not register for VAT, leave registration as long as you can.
This is because being registered for VAT means you have to charge them VAT – but because they’re not registered, they can’t reclaim that back from HMRC, meaning that they feel your prices are higher.
Let’s see how that works.
Jason is our gardener. He’s not registered for VAT. He charges us £20 per hour, so for a morning’s gardening we pay him £70.
But if Jason were to register for VAT, he would have to charge us VAT at 20% on top of what we already pay him. That means he would charge us £70 x 1.2 = £84, an increase of £14, or £4 per hour.
Because individuals can’t register for VAT, we can’t reclaim that input VAT back – so that represents an increase in Jason’s fees as far as we’re concerned.
How to register your business for VAT
You can register either by filling in a paper form or registering online.
HMRC will then process your application and let you know whether or not it has been successful.
It does take time for HMRC to do this, sometimes up to several weeks.
Beginning to charge VAT
Once you are registered for VAT you must make sure that all your invoices for taxable sales are compliant VAT invoices. Most bookkeeping software packages including FreeAgent will do this for you automatically.
Between the date your registration starts and when HMRC issue their acceptance, you need to consider whether you’re going to include VAT in your prices to your customers (you can’t issue VAT invoices yet but you can gross up your prices to include it), or ask them for more money at a later stage to cover the VAT.
So to go back to the example of Jason the gardener, if he were to apply to be registered from 1st April, for each morning’s gardening he did for us in April he could charge us £84 instead of £70 – and then, once his registration comes through, he would need to issue another set of invoices for his April sales, which would need to be VAT invoices compliant with HMRC’s rules.
Alternatively, he could keep charging £70 for a morning’s work in April, but once his VAT registration comes through, he would have to go back over all the sales dated between the date from which the registration takes effect and the date he received the VAT acceptance from HMRC, work out the VAT he would have charged on those sales, and invoice his customers for that VAT - which the customers might not be very happy about.
Invoices that are issued for VAT alone are called “VAT-only invoices”.
Registering for online filing
When your registration comes through, you have to then go through another process to register to file your VAT returns online. From 1st April 2012 all businesses in the UK must file their VAT returns online, with only a few exceptions.
You must also pay all your VAT electronically, rather than by cheque.
But before you can file your VAT return you have to charge and reclaim the right amount of VAT – and that’s what we’ll look at in next month’s article.
Emily Coltman ACA, is Chief Accountant to FreeAgent, who provide an award-winning online accounting system designed to meet the needs of small businesses and freelancers. Try it for free at www.freeagent.com