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SMALL BUSINESS:

VAT - A Small Business Guide



An introduction to VAT for the small business - when do you need to register and when it can be an advantage to voluntarily register

The Basics

The general principle with VAT is that it is a tax on the end consumer and is not generally intended as a tax on businesses. In the simple situation of a business registered for VAT they will charge VAT on their sales (output tax) and will incur VAT on their purchases (input tax). They will report to HMRC their output and input tax for each period and pay to HMRC the excess of their output tax over their input tax or, if input tax exceeds output tax, they will claim a refund. For businesses, then, VAT is generally administered as a pass through tax.

The key issues for the business owner

It is important for the business owner to understand when they are obliged to be registered for VAT and also, if they are not obliged to be registered, whether registering voluntarily is advantageous or not. In administering VAT there are a number of different schemes available that may simplify the administration of their VAT accounting. A key part of both the registration test and administering VAT is determining whether specific goods or services are subject to VAT or not and, if they are, at what rate.

Requirement to be registered for VAT

Businesses are required to be registered for VAT if their turnover of ‘VAT taxable goods or services supplied within the UK for the previous 12 months is more than the current registration threshold of £82,000’. It is first important therefore to be clear that the goods or services supplied by the business are ‘VAT taxable’.

Certain goods and services are held to be outside the scope of VAT (or exempt) from VAT such as land, insurance, finance, education, health and welfare. VAT is not charged on the supply of such goods or services and they do not count for the purposes of determining whether turnover has exceeded the VAT registration threshold. Businesses that solely supply exempt goods or services cannot register for VAT and therefore cannot reclaim their input tax. Exempt goods or services are distinct from the goods and services that are charged at 0% VAT (zero-rated) such as food, sewerage services, water, books and transport. In the case of these items VAT is charged on their supply and they are therefore ‘VAT taxable’ but the VAT is currently set at 0%.

The registration threshold test simply applies in any month to the previous 12 calendar months and is not therefore related to accounting periods or financial years. For a business that is close to the threshold is important that it is reviewed regularly.

Voluntarily registering for VAT

A business engaged in the supply of VAT taxable goods or services can voluntarily register for VAT even if their turnover is below the registration threshold. Consideration needs to be given to whether this will be advantageous to the business. Voluntarily registering for VAT will mean that input tax can be reclaimed on business purchases which will reduce the cost base of the business for determining sales prices. Output VAT will be charged on sales. This is not likely to create a problem when supplying a business customer who is also registered for VAT because they will be able to reclaim the output VAT you charge them. VAT registered customers are also likely to see the benefit of any price decreases associated with the input VAT now being claimed. There may or may not be a perception issue when supplying business customers in highlighting to them, through not being VAT registered, that your business is below the registration threshold.

Retail customers, or customers who are not registered for VAT, are likely to suffer the effect, through increased prices, of your business registering for VAT.

Reclaiming input tax

Generally the input tax incurred by a business can be recovered on goods purchased for resale, business expenses and capital expenditure. Input tax on certain business entertaining and related supplies cannot be recovered and special rules govern the recovery of input tax on business vehicle fuel bills.

Administration

VAT returns are normally produced for 3 month periods and online filing submission and payment deadline is 1 month and 7 days after the end of the tax period. There are specific obligations on VAT registered businesses in terms of the type of records that they must maintain, the length of time they must be maintained for and there are specific rules about the format and information that must be contained in a VAT invoice.

Alternative accounting methods/schemes

There are a number of schemes available for administering VAT that may simplify its operation:

  • Second hand goods scheme – a business trading in second hand goods will often buy them from the public who will obviously not charge VAT on them. Under the normal rules the trader would be required to charge VAT when the items are sold even though no input VAT had been incurred. EU countries operate a margin scheme whereby VAT is only required to be charged on the difference between the traders selling price and the price at which the goods were purchased – i.e. their margin. A global accounting scheme also operates for the bulk purchase of items, which individually cost less than £500, to permit the calculation of the margin based on the bulk purchase rather than for individual items.
  • Optional flat rate scheme – businesses charge VAT on their supplies in the same way but instead of paying over the difference between output and input VAT they pay over a fixed, pre-determined, percentage of their turnover as VAT. Eligibility criteria exist in terms of turnover thresholds and use of other schemes.
  • Special schemes for retailers – create special rules for retailers to work around the ordinary requirement that detailed individual records are kept for every customer transaction.
  • Cash accounting – for businesses with tax exclusive turnover of not more than £1.35m can apply to use the cash accounting scheme whereby VAT is only accounted for on the basis of when cash is received or paid. This scheme can be used in conjunction with the annual accounting scheme and can offer particular benefits to business that experience high levels of customer bad debt.
  • Annual accounting – businesses with annual tax exclusive turnover of not more than £1.35m can apply to account for VAT on an annual basis and make payments on account throughout the tax year.

Next Steps
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Written by Accquant Chartered Accountants
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