The thought of VAT scares the pants off most people, because it’s another tax you have to deal with you might not understand, and you think it’s going to cost you a lot of time money and paperwork.
Here’s the good news!
There’s no need to be afraid of registering for VAT. In fact, you should do it before you even need to, because there are a lot of advantages unless your customers happen to be consumers rather than businesses.
What the heck is VAT?
VAT is a tax that a business needs to charge all their customers, but that the business doesn’t then get to keep. So if you charge a company VAT you immediately have to hand it over to the Government every quarter. By the same token, if you buy something from a company and they charge you VAT, you get that money back from the Government every quarter as well. So you might think, what was the point of that? If you’re just collecting it and giving it back, it makes no difference to you in the long-term. Well, the only time VAT becomes important is if you bill a consumer who isn’t VAT registered because they can’t claim that VAT back from the government, or if you bill small businesses that aren’t themselves VAT registered. Which may mean they don’t want to do business with you again.
How VAT works
The fact is, for most people if you’re VAT registered there’s no net difference to your business, profitability or how much you earn at all, even though you charge VAT. All you’re doing is collecting it from your customers temporarily and handing it over to HMRC. And for all those companies that you took money from, if they’re VAT registered, the same thing happens to them. They pay you the VAT but every quarter they get their money back from HMRC. It’s just a circle of money, and no-one gets any more or less money than they started with. It’s just a strange cash money-go round.
VAT replaced the old ‘purchase tax’ in 1973 and is the third largest revenue generator for the UK government. HM Revenue & Customs use the Value Added Tax Act 1994 to administer the tax. Under EU law, VAT cannot be less than 15%, and each country may have up to 2 reduced rates of tax (in the UK this is 5% and 0%) – so now that we have left the EU – will we get lower VAT at any time in the future? We doubt it very much!
So why does it exist?
Good question. No easy answer! The most crucial thing to know is that if you are not VAT registered you have to pay it but you can’t claim it back. The only people that are hurt by this are individuals or companies too small to be VAT registered. And you don’t need to be a huge company – in fact you can register for VAT when you’ve made £1 of sales. And you have to register if your turnover is more than 90K a year, whether you want to or not.
Why would you not register for VAT then?
Well while you don’t need to register for VAT if your turnover is less than 90K (from 1 April 2024), there would be two benefits if you did, assuming you don’t sell to consumers who won’t like suddenly being charged 20% more. In which case you’ll try to avoid registering for VAT as long as possible.
So are there other benefits to VAT?
If your customers are other VAT-registered businesses there are two huge benefits to registering for VAT.
1. You get money back
For every single product or service that you buy related to the business that has VAT added, like a computer or mobile phone, that amount will be reimbursed to you by the government, so it will end up 20% cheaper. So that’s well worth it in itself. If however, you’re the kind of business that doesn’t have any costs, it won’t matter to you.
2. You get more money back
Let me introduce you to the Flat Rate VAT Scheme. HMRC recognises that VAT is confusing to a lot of people and that it can be really onerous to figure out if everything has VAT added or not. So they’ve come up with the most brilliant scheme in the world – the Flat Rate VAT Scheme. As long as your taxable turnover is less than 150K a year (excluding VAT), you can register for this, and it means you don’t have to keep track of everything. All you need to know is what your sales and turnover are. Say you make 24k a year, you’re going to need to add 20% on to your bills, so that makes a total of £4,800 a year. And because the Government knows what your business category is and the amount, on average, that similar businesses pay when they register for VAT – say 13 % of their sales – they just need to know your total sales figure and then multiply it by 13% (This % varies by industry.) What that means is you’ve charged 20% VAT to your customers, but you only need to pay 13% of your gross sales to the Government – so you’ve just made a bundle. You’ve paid £3,700 to the Government and made £1,000. So it’s well worth registering for VAT. You don’t even need to pay an accountant to fill out your VAT return each quarter – it’s that simple. But be warned that as of June 2017 HMRC has added a test to see if you are allowed to use this industry specific % age - and if you don't meet the test criteria, you have to use 16.5% of gross sales which is almost identical to the VAT you collect from your customers. :(
There are a few exceptions to the rules. For example, if you are convicted of VAT offences within the past 12 months, you’re not allowed to join the Flat Rate party!
So there you have it. VAT is one of those things that may seem scary and doesn’t make sense to people, but it really does pay to register for it unless you sell to consumers, as you’re losing out on money you should be getting. And you can’t let that happen.
There are other rules and exceptions to VAT which are too dull and complicated to put in here, but do let us know if you have any burning questions related to VAT. Our tame tax boffins are more than happy to explain things to you.