VAT (Value Added Tax) is a tax on the supply of goods and services. It's something we take for granted as consumers. As a business however, you need to be aware of the rules around VAT and when to charge it. Businesses must charge VAT if their sales are higher than a certain amount when supplying goods or services to customers in the UK or the Isle of Man.
You may also need to charge VAT on goods and some services imported from abroad.
Keeping good VAT records is important. VAT is overseen by HM Revenue & Customs (HMRC).
Contact HM Revenue & Customs (HMRC) - for up-to-date information and VAT thresholds.
In essence, if you are registered for VAT, you add VAT to all your invoices where VAT is chargeable. At the end of the period, you pay HM Revenue & Customs the total you have charged (output tax) less the total VAT you have paid your suppliers (input tax).
There are three rates of VAT in the UK:
Some items are exempt from VAT, including certain financial services, domestic rent, funeral services and certain types of training and education.
Businesses with a turnover that goes above a certain threshold must register for VAT purposes. Businesses below this turnover threshold need not register, but there may be advantages in doing so: see the section on Voluntary registration. Individuals, not businesses, are registered for VAT purposes. Each registration covers all the business activities of the registered person. This means you cannot hive off parts of your business so that you fall outside the VAT threshold.
Partnerships are regarded as a single entity for VAT purposes. It is unwise for a husband and wife to maintain that they are trading separately without HMRC's agreement in writing.
Limited companies and charities are also regarded as individual entities.
You cannot backdate your registration more than three years from the current date. This means that if you started in business within this time, you can still reclaim the VAT on goods purchased. You would, however, have to account for VAT on any sales made during the same period. This is likely to be very costly for you, as you will have already invoiced most of the sales without charging VAT.
Even if your turnover is below the registration threshold, it may pay to register for several reasons:
You can also register before making any sales at all, providing you satisfy HMRC that there is a "genuine intent to trade". However, you may be required by HMRC to go to some lengths to provide evidence.
You can register by completing an online application or by getting the relevant forms from your Regional Registration Unit. HMRC will check your forms, then send you a certificate of registration. You must put your VAT registration number on every sales invoice and charge VAT on all taxable goods and services.
Register online at the HMRC website
You must charge VAT on all goods and services that you supply unless these are exempt or zero-rated. This includes charging VAT on:
This guide refers to charging VAT, but the VAT system does not give you a clear right to add VAT to your price - this is a point to cover in your contract terms and conditions.
Certain details should be included on a VAT invoice. They include:
You can reclaim VAT on supplies that are wholly and exclusively related to the business, and where you have a VAT invoice - so always ask for and keep receipts, and make sure they have the supplier's VAT number on them.
You cannot reclaim VAT on:
Although you cannot reclaim VAT on supplies that are not made direct to you, there are some circumstances when the rules are relaxed. These include subsistence expenses repaid to employees where the invoices are made out in the name of the employee, rather than the business.
Keep VAT records for six years plus the current year - HMRC can ask to see any item at any time.
Your accounting records must include items such as a VAT account - ie VAT that you have charged and paid for in each period that is covered by your VAT returns, including all zero, reduced and exempt rate supplies.
Any adjustments also need to be recorded, such as changes to your accounts or credits.
Your books must be up to date, and if HMRC feel that these have not been kept in a way that provides enough information, then they can demand changes.
The VAT position on most second-hand goods is covered under a special scheme whereby, rather than account for VAT on the full selling price, you pay tax on the difference between the price that you pay as a buyer, and the price at which you sell.
This "Margin Scheme" is very comprehensive, and can apply to works of art, antiques and collectors' items. Always check your eligibility before applying it, as it is a complex system.
There are also other schemes that may apply - subject to the type of goods being supplied.
Check your eligibility on the HMRC website
It is often impossible to know where a visitor to an Internet website is actually located. Yet whether VAT is chargeable or not depends on where the recipient is: in the UK, the EU or elsewhere.
For goods or services that are actually delivered via the web (by download), it is probably wisest to charge VAT on everything, unless the recipient can prove they qualify for relief.
Without such evidence, HMRC could later ask for the VAT due on all web sales, backdated as appropriate. If you didn't collect any, you would have to fund it out of profits, which could impact your business significantly.
Selling material over the web has changed some previously zero-rated categories to taxable categories.
For example, you might sell zero-rated newsletters or guides and deliver them by mail. However, if you now deliver them electronically over the web, you may have to charge VAT at 20%. Double-check your situation with HMRC if you sell products over the web that are normally zero-rated.
The VAT rules applying to property are very complex and, because of the sums involved, mistakes can be very expensive. So in order to address the VAT situation correctly, seek expert guidance before buying, selling or leasing land or buildings.
There are three main ways to account for VAT:
You account for VAT quarterly based on the invoices issued and received in the period. You pay all VAT due, whether or not your clients have paid the invoices that incurred it.
Usually VAT bad debt relief is not available until the debt is six months' old. However, under the cash accounting system explained below, the problem of VAT on bad debts disappears.
Registered traders whose turnover is not expected to exceed a particular threshold in the following 12 months may use the cash accounting scheme. This allows you to account for VAT based on the actual payments received, instead of on the invoices issued and received.
You can start using this scheme at the beginning of a tax period - you do not need permission to use it.
Cash accounting can improve your cashflow if customers normally take a long time to pay. If your customers pay promptly, you could possibly be worse off under cash accounting because of the loss of input tax on unpaid creditors.
If you start using the scheme, you cannot include VAT on receipts and payments of invoices already issued and dealt with before you started to use the scheme. If you did it would mean you would account for the VAT twice.
You cannot use cash accounting:
You must apply the scheme to the whole of your business. If you find your accounts system is unable to comply with the requirements, or if it proves to be of no benefit, you may leave the scheme.
Once your turnover exceeds the threshold, you are usually able to continue in the scheme until you reach the 25% tolerance limit. You must account for all outstanding tax in the period in which you leave the scheme.
You should account for your payments:
You should be careful, though, if you leave the cash accounting system. This will have a big effect on your cashflow, since you will have to pay the VAT on your receipts from the old cash accounting scheme, as well as on the invoices of the new accruals scheme, at the same time. Also, if you have a seasonal business, you need to watch out that you don't have a large VAT bill to pay from the receipts of the previous quarter, just when business has gone quiet.
Here, regular payments are made on account as agreed, and you complete only one VAT return a year, thus reducing administration and making your business' cashflow more predictable.
The benefits of this scheme include:
Payments on account must be made monthly, quarterly or annually, depending on your overall VAT liability.
If turnover exceeds the scheme threshold then, as with cash accounting, there is a tolerance of 25% so the scheme can be used until the end of the year in which your taxable supplies exceed this level.
There are some disadvantages to the scheme, however. For example, there may be an adverse effect on cashflow caused by variations and interim payments based on earlier years, which may be higher than necessary. You can reduce interim payments but only if there is a significant difference.
Payments must be made by a direct method, such as direct debit.
Unexpected changes in turnover and trading may be taken into account and interim payments adjusted. Any VAT balance at the end of the year must be paid two months after the year-end, when you submit your VAT return.
An alternative simplified scheme is available for low-turnover traders, who can account for VAT on a fixed percentage of their total sales. The percentage will depend on what trade you are in. It is not always advantageous, so you should carefully review the likely impact.
There are various penalties for late payment, late registration, errors, and not submitting a VAT return on time. For example, for the first late payment the surcharge will be 2 per cent of the tax outstanding at the due date. The level of surcharge will then increase progressively to 5 per cent, 10 per cent and 15 per cent for further payment defaults.
HMRC has the right of access to premises and records at any time. Your records must be up to date and easily understood.
HMRC officers may visit to look at records to make sure that you are paying the right amount of tax and duty, and that you are complying with all the requirements. However, if they can resolve an issue by phone or letter, they will.
The frequency of visits depends on the size and complexity of your business, but expect an inspection every three years or so. The visit itself may take a couple of hours or a few days, again depending on your business.
HMRC will normally tell you what it will need to see, and for what accounting period, before visiting, and arrange a time that is mutually convenient. You can request a written report after the visit, and if you disagree with any of the decisions, you should put it in writing, clearly stating your case.
The best person to represent you during a visit is someone who knows your accounting systems - the more helpful information you can provide, the shorter and less stressful the visit. You may want your accountant present to deal with any problems that may arise.
VAT is complex, and the amounts involved over a period of six years can be large so, if you are in doubt, seek clarification from your local HMRC office or an accountant.
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