What is VAT, how does it work and who pays it? When is VAT registration compulsory and what are the advantages and disadvantages of voluntary registration? How much VAT should you charge and how do you complete your VAT returns and payments? All businesses need to understand VAT - even if you do not charge it at present it is important to be aware of the right VAT schemes for particular businesses. This article outlines the basics of VAT and also what small businesses can do to make VAT simpler. There are additional, relevant VAT articles on the Duport website which you should also consider. These include how to set up records and invoice correctly for VAT, how to file returns online, what to do if you have VAT payment problems, plus a separate checklist on when you can reclaim VAT and when you can’t.

of course, on the downside you have to fill in regular VAT returns with details of your sales and purchases

what is VAT and how does it work?

Value Added Tax, or VAT is a tax that applies to most business transactions involving the transfer or goods or services. Once your business turnover reaches a certain level (see below) you legally have to pay VAT to HM Revenue & Customs. A business pays VAT on its purchases (known as input tax) and charges VAT on its sales (output tax). If a VAT registered business receives more output tax from sales than it pays on input tax, it has to pay the difference to HM Revenue and Customs. If more input tax has been paid out (on, for example equipment, goods and supplies) than the company has charged VAT for on its sales, the Revenue refunds the difference.

When does registration for VAT become compulsory?

You must register your business for VAT if you supplied taxable goods and services amounting to more than £64,000 in the last 12 month period or if you anticipate supplying taxable goods and services amounting to more than £64,000 in the next 30 day period alone. The government sets the figures and they may change in the future.

There are certain types of goods and services that are exempt from VAT, for example insurance, loans, and some education and training. If your business supplies only goods and services that are exempt, then you do not have to register, fill in VAT returns or make payments. However, you cannot claim the VAT back on your purchases.

why would I want to register for VAT voluntarily?

Despite the hassle of keeping VAT records and the small mountain of paperwork that goes with the territory, there are advantages to registering voluntarily when a business has a turnover below £64,000. Obviously it means you can reclaim the VAT you pay out on goods and services, which can be considerable depending on your business. It can also increase your credibility as a business as some companies prefer dealing with suppliers with a VAT number. Having a VAT number can imply confidence, stability and the impression that the business is larger than it perhaps is. In addition, if you supply goods to other VAT registered businesses then they can also reclaim the VAT charged.

Of course, on the downside you have to fill in regular VAT returns with details of your sales and purchases, and the accompanying paperwork soon mounts up. Furthermore if your suppliers are to the public or non-VAT registered businesses then they cannot reclaim the VAT charged, so your prices might be less competitive than someone not charging VAT. It really depends on what type of business you have, and a recommended, qualified accountant should give sound advice.

what changes would I need to make when I register for VAT?

As soon as you are VAT registered you must issue VAT invoices on all your sales (see separate article on setting up records and invoicing correctly).You need to keep a detailed record of the amount of VAT you charge (i.e. your output tax).

When you make purchases you must remember to get a VAT invoice so you can reclaim any VAT paid. Keep records of the amount of VAT paid for each purchase along with your original records.

what rates of VAT should I charge?

There are three rates of VAT and it is important to know which rate to charge. The standard rate is 17.5%, there is also a reduced rate of 5% for certain goods and services and there is a zero rate for certain goods and services. For example, loans of money, insurance, certain types of education and training and some property transactions are exempt. Even if you only supply goods that are zero rated - for example books, newspapers, young children’s clothing and shoes or food (although not food sold in cafes, bars etc) you still have to tell C&E first and apply to be ’exempt from registration’. Check its website to see exemptions and lists of goods and services charged at 5% or zero. Remember, you cannot claim VAT back on purchases if your business supplies only goods and services exempt from VAT. But if your business supplies other goods that are not exempt, then you are classed as partly exempt so you need to check when you can claim VAT and when you cannot.

when do I complete VAT returns and make payments?

People dread their VAT returns, but there is lots of help and guidance from the tax office and online. Businesses usually account for VAT on a quarterly basis. When you register you will be assigned a tax period and will automatically receive a VAT return to coincide with the end of this period.

The VAT return details how much is payable and how you have calculated it. (See separate article on how to complete a VAT return.) Your completed VAT return and payment of whatever tax is due is usually one month after the end of your tax period.

You can of course submit the return online and arrange for an electronic payment. (See separate article on submitting VAT returns online).

how can I make VAT easier for my business?

There are a number of simplified arrangements to make VAT accounting easier for small businesses. If your taxable turnover is under £660,000 a year you can arrange to account to Customs for VAT on the basis of cash received and paid, rather than the invoice date or time of supply. This “cash accounting” helps cash flow and is particularly useful if you have a lot of late payers. Consider “annual accounting” where instead of completing quarterly VAT returns, a small business with taxable turnover under £660,000 can send in returns once a year. If you are a retailer there are schemes which offer you an alternative if it’s impractical to issue invoices for a large number of supplies direct to the public. There is also “bad debt” relief which you may be able to claim if you do not get paid.

And finally, if your turnover is under £150,000 you can save on administration because you do not have to account internally for VAT on each individual “in and out”. You simply pay over a set percentage of your total turnover. The rate depends on your business type.

VAT is a fact of life for most businesses and has to be dealt with on a regular, systematic basis. It may not be exciting or stimulating, but it still has to be sorted. Like most other business practices, once a straightforward system is in place and adhered to life becomes easier. Do not let the paperwork mount up or be lax about your VAT obligations. If you really can’t face it yourself then a book-keeper can take most of the pain away, but you still need to be on top of the system. The government website is good and you can also download many of the forms needed www.hmrc.gov.uk