Should I register for VAT?

What Does Tax Return Deadline MeanThis is a question that is often asked by small business owners and people wanting to start their own business. Depending on your circumstances, VAT registration could be mandatory or you could decide to register voluntarily or not at all. In this article we will cover the main issues to help you decide.

What is VAT?

VAT (Value Added Tax) is a tax that is charged on most business transactions within the UK. It is also charged on some business transactions within and outside the European Union. VAT-registered businesses add VAT at the appropriate rate (usually 20%) to their prices for goods they sell or services they provide to their customers. It doesn’t matter if a customer is another business or a member of the general public; VAT-registered businesses must add VAT to their selling prices.

Different rates of VAT

There are three rates of VAT. The nature of the goods or services being supplied will determine the appropriate rates to be used for the transaction:

  • Standard rate – 20% and applies to most goods and services that are subject to VAT
  • Reduced rate – 5% and applies, for example, to domestic fuel and power
  • Zero rate – 0% and applies, for example, to fresh food, children’s clothes and shoes

Some goods and services are exempt from VAT and others are outside the scope of UK VAT system altogether. We will not discuss these in this article.

How does VAT work?

As I said above, VAT is a tax and so the VAT that is added to prices is not additional income for the business. A VAT-registered business is essentially a tax collector for HMRC (Her Majesty’s Revenue & Customs) and the VAT that is charged to customers must be paid to HMRC.

Typically this is done every three months by submitting a VAT Return to HMRC, which summarises the sales and VAT that has charged to customers during the period (the ‘Output VAT’) and the purchases and VAT that has been charged by suppliers during the period (the ‘Input VAT’).

The amount to be paid to HMRC is the Output VAT minus the Input VAT. So VAT-registered businesses can recover the VAT they are charged by their suppliers. Indeed, if Input VAT exceeds Output VAT in the period, which can happen for example if there has been a significant purchase of assets or stock, HMRC will actually refund this difference.

This isn’t as generous as it appears because, of course, the suppliers of those assets or stock will be paying HMRC the Output VAT on their sales. And so the charging, collecting and paying of VAT is carried on up the supply chain until a customer that is not VAT registered buys the goods or services. Here the VAT chain ends and it is this customer (business or individual) that ultimately pays the tax.

Must I register for VAT?

The question of whether your business should register for VAT is not entirely voluntary. If your total sales for the last 12-month period exceed £79,000 (or you think it is about to), it is likely that you will be legally obliged to register for VAT – no ‘ifs’ or ‘buts’. Note that this applies on a rolling 12-month basis and not a calendar or accounting year. Failure to register can result in fines imposed by HMRC.

If your total sales in a 12-month period are below £79,000 (this is called the ‘VAT threshold’), you do not have to register for VAT but, depending on your circumstances, it may be beneficial for you to do so. So what are the advantages and disadvantages of being a VAT-registered business?

Advantages of VAT registration

  • It makes your business look more legitimate. The fact that you are VAT registered psychologically reinforces the impression on your customers that you are working as a professional outfit.
  • It suggests stability and financial security. Because businesses are obliged to register for VAT once they have £79,000 of annual turnover, by voluntarily doing so would suggest to would-be customers or clients that you have already reached this threshold and that you are a financially secure, professional enterprise. Not only does it convey general success, it would reassure your clients or customers that you have financial reserves to support ongoing supply of products and services to them.
  • You can recover VAT that your suppliers charge you. As I explained above, VAT-registered businesses can recover the VAT they are charged by their suppliers as this reduces the VAT that must be paid to HMRC.
  • VAT would not be a cost to your VAT-registered customers. They would recover the VAT that you charge them in the same way that you would from your suppliers. Therefore, if your customers are mostly VAT-registered businesses themselves, adding VAT to your prices in itself need not affect your profits or theirs.

Disadvantages of VAT registration

  • VAT inflates your prices. VAT-registered businesses’ prices are immediately inflated by the rate of VAT (usually 20%). If you are not VAT registered, you can either undercut your VAT-registered competitors’ pricing quite easily or you could possibly match their prices and actually take more profit than them on like-for-like sales.
  • VAT would be a cost to your customers that are not VAT registered. They could not recover the VAT that you charge them and so this would increase the costs of their business. Therefore, if your customers are mostly not VAT-registered businesses, it would probably not be appropriate to register for VAT until you have to.
  • Paperwork and administration. More diligence is required to manage your accounting records as you will have to submit your VAT return once every 3 months and retain supporting documentation for at least six years. This, however, is less onerous than it once was due to easy-to-use accounting packages, such as Prelude Accounts.

Different VAT schemes

If you do register for VAT, there are a number of schemes to calculate, report and pay VAT to HMRC. You have some choice as to which scheme you can adopt but the size and nature of your business are the main criteria. We will not discuss these in this article but here are the three main ones:

  • Standard (or Accrual) Scheme The amount of VAT you owe or recover is based on the invoices that are dated during a period. This can cause cash flow problems if a VAT payment to HMRC becomes due before your customers have paid you.
  • Cash Accounting Scheme The amount of VAT you owe or recover is based on the dates of payments made and received during the period. This removes the cash flow problem as VAT payment to HMRC becomes due only after your customers have paid you. This scheme is available only to certain small businesses.
  • Flat Rate Scheme (FRS) This scheme applies to certain industries and can have a cash flow benefit in some circumstances. HMRC assign you a flat rate of VAT depending on the industry in which your business operates, for example 12%. You charge VAT at the appropriate rate (e.g. 20%) but you pay HMRC only 12% of your gross (i.e. inclusive of VAT) sales. This benefit is reduced because you cannot recover VAT on your purchases (with some exceptions) like you can in the other schemes.

Further help and advice

This article is by no means an exhaustive review of VAT. The amounts, thresholds, rates and schemes referred to are current at the time of writing. If you are in any doubt as to whether your business should or must register for VAT, consult with an accountant immediately as they will ensure that your financial affairs remain legal and are appropriately recorded.

As I already mentioned, you may not have a choice in the matter if your business already has sales in excess of the VAT threshold, but for those of you who run small operations it might be worth considering the pros and cons of doing so.

Ultimately, you can always contact HMRC. Their helpline should be able to answer all your questions.