Managing Your Cash Flow

VAT: Everything you need to know

6 min read

06 October 2015

VAT doesn't need to be taxing. This guide will give you all the answers you have about VAT in the UK.

Lots of people panic about whether to go VAT-registered when they start up. It’s an important decision to make and can influence your financial success. So what questions should you ask?

What is VAT?

VAT raises income for the government and stands for Value Added Tax – the amount of tax added to the value of goods or services you buy. All VAT-registered businesses must charge VAT on the goods or services they provide.

The standard VAT rate is 20 per cent, which means you must add 20 per cent to all sales. So for example, you add £20 to a £100 bill if you are VAT-registered.

The good news is that VAT-registered businesses can claim back any VAT they are charged. HMRC will offset the amount you are charged against the VAT you owe from making sales of your own.

Is everything taxed? 

No. Some services are “exempt” such as education and some are “zero rated” such as books. There’s also a “reduced” rate of 5% for certain consumer goods, including fuel and energy-saving products. If you sell only goods that are deemed exempt then you don’t need to register for VAT.

Does my revenue play a part?

Yes, if your sales exceed £82,000 per annum then you must register for VAT. This is the “VAT taxable turnover” so you need to be aware of how VAT could effect your business as you grow. You can register voluntarily below this threshold.

Why would I do that?

If the clients you serve are mainly VAT-registered then it’s worth becoming one too. Your clients won’t see the VAT as an administrative chore as they will be in the habit of claiming back the VAT.

There are three reasons why you would voluntarily register:

1. Credibility

Being VAT-registered can help to give the impression you’ve been in business longer than you have. This is also especially helpful if your turnover is less than £82,000.

2. To access the flat rate VAT scheme, a way to make a small profit as a services company

If your business has a low level of outgoings, you may stand to benefit financially from becoming VAT-registered, and in particular take advantage of the flat rate VAT scheme – we’ll go through this in the next section.

3. If you are a contractor 

If you’re self-employed and find work through an agency then you should consider registering for VAT. You’re likely to have low outgoings and can therefore benefit from the flat rate VAT scheme.

So what is the flat rate VAT scheme? 

The standard 20 per cent VAT scheme requires businesses to keep accurate records on every transaction noting the VAT paid or charged. The VAT Flat Rate Scheme (FRS) was introduced by HMRC to simplify this process and gives businesses with minimal expenditure a chance to make a small profit.

With FRS, instead of tracking VAT on all transactions, you simply pay a fixed flat-rate percentage of your gross turnover to HMRC. The percentage you pay is set by HMRC, and varies according to your industry. For example, IT contractors will pay flat rate VAT at 14.5 per cent. This means you’ll still charge your clients VAT at 20%, but you’ll only pay 14.5% of the invoice amount to HMRC – the difference is yours to keep.

The flat rate VAT scheme will benefit most businesses that have a turnover of less than £150,000 in the first year. However, if you have a lot of expenses that incur VAT or if you provide goods or services that are zero rated, charged at lower rate or are exempt then the flat rate scheme might not be for you. This is because the difference between what you charge and pay HMRC through the Flat Rate Scheme may not cover the VAT you incur through business expenses.

When should I not voluntarily register?

It’s not worth registering if you’re providing goods and services to business who can’t reclaim the VAT. By charging VAT you needlessly increase your prices by 20 per cent.

I’m ready to register. What do I do?

Register directly with HMRC, keep precise records of all VAT related transactions and hold the evidence for six years. You’ll need to file a VAT return with HMRC every quarter and pay any VAT due. If you’re using the flat rate VAT scheme you’ll simply calculate and pay a percentage of your turnover, otherwise you must account for all the VAT you’ve charged, and deduct all of the VAT you’ve paid. 

James Poyser is co-founder of inniAccounts.