Tax at the point of sale
VAT stands for Value Added Tax. As the name suggests, it’s collected any time value is added to a product. Businesses have to pay VAT to Her Majesty’s Revenue & Customs (HMRC) when they sell or hire out goods or services. There are some exceptions, such as sales outside the UK. But for many businesses, VAT applies to every sale if you’re VAT registered.
It doesn’t matter if your customer is another business or a consumer. However it is possible to reclaim the VAT charged on business expenditure – so long as you’re VAT registered.
When should you register for VAT?
It’s compulsory to register for VAT once your taxable turnover exceeds the VAT registration threshold. This must be checked on a rolling 12 month basis, not just at your accounting year end. The VAT registration threshold can change from year to year, so check it here. Once you pass the threshold, you have 30 days to register. You can register online. Your effective VAT registration date will be the first day of the second month after you go over the registration threshold.
You should also register for VAT if you expect your VAT taxable turnover to be more than £85,000 in the next 30-day period. As mentioned above, you have 30 days to register with the effective registration date being the day you realised your turnover would exceed £85,000 in the next 30-day period.
If your business earns less than the threshold amount, registering for VAT is optional, but there are some good reasons for doing so.
Advantages of registering for VAT:
- You can reclaim VAT paid for business purposes:
- Business supplies such as computers, desks, chairs and utilities have VAT applied to them. You’ll need to pay VAT on those business supplies at time of purchase, but you can reclaim it from the government when filing your VAT return.
- It looks professional:
- Being VAT registered makes you look more professional to other businesses. It can also hide the fact that your turnover may be lower than the compulsory VAT threshold.
Disadvantages of registering for VAT:
- You’ll have to charge more:
- You’ll need to add VAT to your prices. It shouldn’t make you more expensive than your competitors, though, as most of them will have to do the same. And if you sell to VAT-registered businesses, they’ll be able to claim the VAT back.
- You’ll have to do more accounting:
- You’ll need to pass on the VAT you’ve charged to the government and submit quarterly VAT returns.
Choosing a VAT scheme
Once you’ve registered for VAT, you’ll need a system for telling the government:
- how much VAT you’ve charged
- how much VAT you’ve paid
Standard VAT accounting method
The usual method is to keep a detailed VAT record of all purchases and sales. From April 2022, businesses registered for VAT must keep digital records and submit their VAT returns using compliant Making Tax Digital (MTD) software or a bridging tool if a spreadsheet is used to record VAT purchases and sales.The information recorded is then used to complete a VAT return.
You can apply for a Making Tax Digital for VAT exemption if it’s not reasonable or practical for you to use computers, software or the internet to follow the rules for Making Tax Digital for VAT.
You must file the return with HMRC and pay any VAT that’s due. If you have paid more VAT than you have charged you will be able to claim a VAT refund.
Other VAT accounting methods
There are three alternatives to the standard VAT accounting method:
This is just like the standard VAT accounting method, except that you don't fill in quarterly returns. Instead you have an annual VAT reporting and payment deadline. Some businesses keep this the same as their corporation tax filing date, for simplicity.
Once you complete the VAT return, you start making quarterly interim payments for the VAT you estimate that you’ll owe. This method allows you to budget more carefully and because payments are spread throughout the year, it’s often better for cash flow. However, you may end up over-paying or under-paying HMRC at times, so you may be required to make a final balance payment or apply for a refund. Businesses with annual turnover above £1.35 million can’t use the annual accounting scheme.
Under this scheme, you simply pay a percentage of your total turnover as VAT. The actual amount you pay depends on the type of business you run – different industries have different flat VAT rates. You must also consider if your business would be classed as a ‘limited cost business’ when looking at which percentage of VAT you would pay to HMRC.
You'll still have to charge VAT on your invoices, but you don't have to account for the VAT details of every purchase made. Only smaller businesses, with annual turnover up to £150,000, can use this VAT scheme. Check with HMRC to find out whether yours is eligible.
With cash accounting, you account for VAT on the date you’re paid as opposed to the date you send the invoice. This can be especially helpful if you have slow payers, since you won't have to pay VAT before you’ve been paid.
However, this option isn’t well suited to businesses that buy a lot of items on credit. You can't reclaim the VAT until payment has been completed. As with the standard VAT accounting method, you still have to complete your returns every quarter. Businesses with annual turnover above £1.35 million can’t use the cash accounting scheme.
Get the right VAT advice
VAT is relatively straightforward but there are some pitfalls. It's a good idea to talk to an accountant to help you choose the best VAT scheme for your situation.
Different accounting schemes suit certain types of businesses. Consider looking for an accountant with other clients in your industry as they’ll know the pros and cons. And be aware that the size of your business can also affect your choice.
VAT accounting is a legal obligation
You’re required to register for VAT once you pass the registration threshold. And then you’re obliged to maintain your VAT accounting records. As noted above, from April 2022, you are required to maintain your records digitally whether that is in compliant software or a spreadsheet.
HMRC can charge significant fines to businesses that fail to accurately account for VAT. Late filing, late payment and incorrect information can also be heavily penalised. Make sure your returns are accurate and on time.
An accountant can help keep you compliant, while software can automate data capture and reporting. Together, they’ll streamline your tax filing. VAT accounting may be an obligation, but it doesn't have to be a chore.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the provided content.