What you need to know about VAT for startups
We’ve all heard of Value-Added Tax, or VAT. And we know we pay it on the goods and services we buy. But how does VAT affect the running and taxation of your new startup business? Aldrich Walker from Stern accountants gives you the lowdown on registering for, accounting for and paying VAT.
What impact does VAT have?
Whether it’s a service you provide, a product you make or a biscuit you bake, your job is to collect the VAT on that product or service and then pay it to HM Revenue & Customs (HMRC) – unless it’s a Jaffa Cake, which is infamously classed as a VAT-free cake, not a luxury biscuit.
Having to charge VAT once you reach the registration threshold can have a significant impact on your competitiveness, especially if you’re a retail, manufacturing or production company. As a startup, it’s worth considering when you will need to add VAT in the future as it will either eat into your margin, or force up your wholesale/retail price, consider the example below:
You start up a widget business, and can buy a widget for £9 and sell them for £12, your £3 margin gives you a competitive edge when starting out compared to the competition, however as soon as you reach registration you either:
Leave your selling prices at £12, £2 has to be paid to HMRC for the VAT so your net selling price is only £10 and your margin is only £1, or
You increase your selling price to £14.40 (£12 plus VAT), your margin remains at £3 but the selling price of £14.40 means you will lose the competitive edge
So, it’s worth thinking very carefully about when, and if, the time is right to register for VAT.
When does my startup need to start paying VAT?
The magic number is £83k. When the turnover of your startup gets to £83,000, you must register for VAT with HMRC and start collecting and paying the tax on your eligible products/services.
With that magic number ingrained in your mind, here are some practical tips for making sure your startup is ready for VAT:
Keep an eye on your turnover figure – have a regular overview of your turnover (easy to do if you’re using cloud accounting software) and check how close sales are bringing you to £83k. Once you’re close, start planning ahead for paying VAT.
Do some financial housekeeping – it helps enormously if your financial processes are working efficiently and giving you the numbers you need. Clean up any messy accounting and give your finances a spring clean so you’re ready to roll.
Register early – as soon as you start approaching £75-£80k turnover, register for VAT. The registration process only takes two weeks or so, but the sooner you start, the more ready you’ll be for the additional admin that VAT requires.
Plan your quarterly VAT payments – your startup is responsible for paying VAT to HMRC every quarter. So it’s sensible to have a separate deposit account for VAT and to work those payments into your budgeting and cashflow for each quarter.
You can register for VAT even if you’re not up to the £83k mark. Some startups will register for VAT early to add a little kudos to the brand and give the impression they’re a bigger concern.
Registering right from the start shows prospective customers and investors that you’re deadly serious about growth and a serious player in the market. But bear in mind the potential impact of paying VAT and the effect it can have on cash flow and margins.
How tricky is VAT to set up?
Registering for VAT isn’t hugely complex – if you’ve got some finance experience, you could do it yourself. But there’s real value in getting your accountant involved right from the beginning.
Anything to do with HMRC can make people nervous, and working with a VAT specialist helps to remove any worries and free up your time to focus on growing your fledgling startup.
There are different ways to account for your VAT, and an accountant can help you decide on a method that makes the most sense for your particular startup.
Accrual accounting – the accrual method involves paying your VAT based on the invoice or purchase date. So, if you invoice your customer in one VAT period but don’t get paid until the next quarter, that VAT is payable in the earlier period.
The cash flow problem – if your invoices don’t get paid on time, that racks up debt and you can end up with cash flow issues at the point when VAT is due.
Cash accounting – to simplify the VAT process for small businesses, you can apply to HMRC to use cash accounting (if your turnover is under £1.35m). With this method, you account for VAT only once payment has been received, not from the date the invoice was sent – removing the potential cash flow issue.
Flat-rate scheme – to make VAT even easier, you can also apply for the flat-rate scheme. You continue to charge VAT at the relevant rates, but when it comes to paying HMRC, you pay a simple flat rate on everything. You simplify your bookkeeping, pay less in VAT and keep money in the business to invest in growth.
VAT needn't be taxing
So, there you have it. VAT’s not as scary as you thought, is it? With the right awareness, forward planning and professional advice you can make VAT work for your business – and even improve your cash flow and annual profits.
Our top 3 actions points are:
- Move to cloud accounting and keep a close eye on when that £83k turnover is close.
- Plan your tax costs and squirrel your VAT away so it’s ready to pay each quarter.
- Talk to an accountant and use the accounting method that best suits your startup.
Aldrich Walker is an account manager at Stern, a leading West London Xero accounting partner and business advisers. He’s been a chartered accountant for over 20 years and specialises in helping small businesses deal with their accounts, tax and VAT.