An introduction to VAT

A financial transaction is considered within the scope of VAT if there is a supply of goods or services made in the UK by a taxable person in the course of business.

You are legally required to register for VAT if the value of your taxable supplies exceeds a set annual figure (£85,000 from 1 April 2018).

You count the previous 12 months on a rolling basis, this assessment is not linked to your accounting year end. If it only takes 6 months to reach the registration threshold you'll have to register after 6 months.

Taxable supplies are mainly either standard rated (20%) or zero rated (0%). There is in addition a reduced rate of 5% which applies to some specific taxable supplies.

Some supplies that are not taxable are known as exempt supplies.

  • If your business is making only exempt supplies you cannot register for VAT and therefore cannot recover any input tax.
  • If your business is making zero rated supplies you should register for VAT as your supplies are taxable (but at 0%) and recovery of input tax is allowed.

VAT registered businesses effectively act as unpaid tax collectors and are required to account promptly for all the VAT collected by them.

HMRC can impose heavy penalties for breaches of the VAT legislation and ignorance is not considered to be an acceptable excuse for not complying with the rules.

VAT registered businesses charge VAT on their sales. This is known as output VAT and the sales are referred to as outputs.

VAT charged on goods and services purchased by the business is known as input VAT.

The output VAT is being collected from the customer by the business on behalf of HMRC and must be regularly paid over to them.

Any input VAT paid for on the goods and services purchased can be deducted from the amount of output tax owed. There are some exceptions where certain categories of input tax can never be reclaimed, such as in respect of business entertainment and for the purchase of most business cars.

What you need to know...

Voluntary Registration

If you are making taxable supplies but at a level below the registration limit you can apply for voluntary registration.

By being registered voluntarily you can then reclaim input VAT, which could result in a repayment of VAT if your business was making zero rated supplies.

Also, if you have just started in business a voluntary registration allows you to recover input tax on start up expenses.

Another possible benefit is to give the impression your business is larger and more established than it really is.

You should avoid voluntary registration if your customers are mainly private householders and not other vat registered businesses, because you'll become more expensive when compared to your competitors.

Taxable Person

A taxable person is anyone who makes or intends to make taxable supplies and is required to be registered.

If any individual carries on two or more businesses all the supplies made in those businesses will be added together in determining whether or not the individual is required to register for VAT.

Submitting Returns

Following registration you will usually make a quarterly return to HMRC showing amounts of output tax to be accounted for and deductible input tax.

Each time you submit a vat return to HMRC you pay, or receive, the difference between the output tax and input tax.

A return must be completed within one month and seven days of the end of the period it covers.

Electronic payment is compulsory for all businesses.

VAT Cash Accounting

Many of our clients calculate their VAT on a 'cash accounting' basis.

This enables a registered business to account for and pay VAT on the basis of cash received and paid rather than on the basis of invoices issued and received.

The advantages of this are:

  • Output tax is not due to be paid to HMRC until after the business receives payment of its sales invoices.
  • There is automatic bad debt relief because, if no payment is received, no output tax is due.
  • It's easier to make accurate cash flow projections.

A business can join the cash accounting scheme if it's taxable turnover in the next 12 months will not exceed £1,350,000.

All standard and zero-rated supplies count towards the £1,350,000 except anticipated sales of capital assets previously used within the business. Exempt supplies are excluded.

A business can start using the scheme without informing HMRC.

You cannot use cash accounting in the following circumstances:

  • for goods bought or sold under lease or hire-purchase agreements
  • for goods bought or sold under credit sale or conditional sale agreements
  • for supplies invoiced where full payment is not due within six months
  • for supplies invoiced in advance of delivering the goods or performing the services.

If annual turnover reaches £1,600,000 a business must leave the scheme.