Managing Your Cash Flow

Everything you need to know about VAT as an SME owner

9 min read

11 December 2018

Reporter, Real Business

Whether you're a VAT whizz-kid or a business owner who needs a little clarification, our easy-to-read VAT guide tells you all you need to know about VAT including how to register for it.

When you’re running your own business, chances are you’ll be heavily involved in all aspects of its operation, this includes VAT obligations.

But what exactly is VAT and why do you need to know about it?

We’ll explain all in this detailed guide which is ideal for those starting their own business, or for those SME owners who simply need a little refreshing on the subject.

Let’s start out by getting the low-down on what VAT stands for…

VAT 101:

VAT or Value added tax, as it is also known, is a tax which is charged when a VAT registered business sells goods or services.

Essentially, VAT is a sales tax that’s collected by businesses on behalf of the government.

A business which is registered for VAT will charge VAT to its customers at a rate set by HM Revenue & Customs (HMRC).

However, the rate does vary and will be dependent on what is being sold, although most supplies are taxed at 20%.

How does it work?

Let’s picture a purchasing scenario. When a customer engages with a business and buys a product, the customer pays the VAT to the supplier at the same time as paying for the goods in question.

The supplier (the business in question) collects the VAT and pays it over to HMRC at certain intervals during the year.

However, it’s important to remember that this amount collected doesn’t belong to the business that charged the VAT.

From a customer perspective, and if the customer is VAT registered themselves, VAT can be charged to them and be reclaimed from HMRC.

To find out what they need to pay, they can do this by completing a VAT return.

When you’re a business that’s engaging with suppliers, be sure to always double check your invoices. Why? Because it’s important you ensure that the right amount of VAT has been charged to you.

What is the rate of VAT?

Keeping on top of VAT payments isn’t as complicated as you might think.

The rate of VAT to be charged by the business is predetermined. This means that it’s based on the item that is being sold or the service being offered.

There are three rates you need to know about. Here they are below:

1. Standard rate (20%) – this applies to most goods and services
2. Reduced rate (5%) – this applies to energy supplies in the home including gas and electricity 
3. Zero rate (0%) – includes books and newspapers, children’s clothing, public transport and most food 

When should I charge VAT?

When you’re a functioning business, it’s important to know when you should be charging VAT.

Ensure you maintain best practices and keep your company looking compliant and professional by keeping note of the points below:

Here’s when you SHOULD be charging VAT:

1. When your business is VAT registered (whether compulsorily or voluntarily) 
2. When your business has produced a taxable supply of goods or services 

What constitutes as ‘taxable items’?

Taxable sales will include any items sold where VAT has been charged at any of the above rates (even at a zero rate).

However, certain items will be exempt from VAT, these include:

Insurance, education, and training, subscriptions, doctors and dentist services.

There are even things that are outside the VAT sphere, such as employment income and dividends received.  As such, these items will not be included in your taxable sales figures.

Preparing your invoices

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You will need to state the rate of VAT applicable to the sales of all of your items when you’re preparing your sales invoices.

If you’re after a shortcut, you can use software where you only have the calculate the VAT amount once when uploading your product into the system.

Usually with these software packages, once the rate of VAT has been set, each product will be allocated a code.

These codes will be used when preparing invoices and the VAT (at the relevant rate) will be calculated automatically.

This method can take time and pressure off your VAT obligations that you’ll need to be undertaking.

The UK government has compiled a list of reputable and reliable software packages that can help business owners deal with their VAT obligations effectively, read about them here.

Getting assistance

Whilst quite a few businesses prepare their own VAT returns, if you can spare the expense, using a bookkeeper or accountant to tackle your VAT obligations is also a good idea if you’re still not confident about dealing with them.

The relationship between VAT and your customers

When your business become VAT registered, you will need to start keeping VAT records.

These records should include details of the VAT you have been charged as well as the VAT you have charged your customers.

If you want to retain as much of the sale yourself as before, (which of course all sensible businesses want to) then the price that your customer pays for the product will automatically increase.

When it comes to the customer, and if they are VAT registered, their VAT status differs to you as a business owner.

Any VAT charged to customers can be reclaimed (rules do apply here though as some VAT charged is non-reclaimable e.g. VAT on a car purchase).

However, when your business is selling to a private customer, then they are unable to reclaim the VAT. This can make your business appear more expensive when it comes to obtaining goods and services.

Selling goods to private customers

Here is a scenario to help you picture the private customer issue a little better.

Let’s say there is a painter and decorator that does work in both commercial and private properties.

The VAT charged on the commercial work isn’t an issue as the customer is likely to be VAT registered, meaning they will be able to recover the VAT charged to them.

However, the private customer won’t be able to do this. Therefore to save money, they may look for a painter and decorator that is not VAT registered to cut costs.

However, a small business that is VAT registered can be appealing to other businesses and customers: and can even be good PR, as it gives the impression of being a more established business.

Do I need to register for VAT?

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Once your overall takings (excluding exempt items and ones outside the scope of VAT) for the previous year exceeds the VAT registration threshold (£85,000 from 1 April 2017) you are legally obliged to register for VAT.

However, a small business owner does not need to wait until they hit this threshold – as many will choose to register voluntarily as it looks good for both investors, stakeholders and customers if they do so.

When it comes to VAT there are deadlines and penalties they must be aware of.

Business owners must be meticulous and organised when it comes to keeping on top of VAT payments, and if they plan ahead and know when they need to be paid, they can avoid the business damaging effects of fines.

Want to register for VAT? Then follow the government’s guide here.