You will have heard of Value Added Tax (VAT), you will have paid VAT, but you may not have had to understand how the system works.
If you need to now, after setting up a limited company, here’s an introduction to VAT, what it’s all about and how to register for it.
It sounds really simple – you charge a tax on sales, you reclaim the tax charged to you, and then pay over the balance.
As you’ve probably guessed by now though it doesn’t always work as easily as that. It is a complex process and one that many people get wrong with expensive consequences.
As a result they can end up paying tax they didn’t expect to and incur penalties on top!
We’ve put this guide together therefore to help you understand a bit more about the pitfalls so you don’t get caught out!
What is Value Added Tax (VAT)?
The simple answer is VAT a sales tax and the official explanation is as follows:
‘VAT is a tax chargeable on taxable supplies made in the UK by taxable persons. Credit is given for tax paid to other businesses and the net balance is payable or reclaimable.’
In simple English a ‘taxable person’ is someone or something that is carrying on a business. ‘Supplies’ refers to both goods or services (outputs), whether of a revenue or capital nature.
This includes the sale, hire, or loan of goods. So if you are in business supplying anything and getting paid for it, then you probably need to think about VAT.
That’s me – what do I need to do?
You should register for VAT with Her Majesty’s Revenue & Customs (HMRC) when your sales of vatable supplies is greater than £90,000 or if you know that you are going to exceed that threshold within 30 days.
If your sales are below the threshold, it is possible to register voluntarily provided you have a bona fide (i.e. genuine) business.
There are then 4 types of treatment of these supplies for VAT:
- Positive rated – taxable at 20% or 5%
- Zero rated – these include socially or economically important items. For example exports, most food but not meals in restaurants or hot takeaways, books, newspapers, public transport, drugs on prescription and children’s clothes and shoes.
- Exempt supplies – includes necessities such as education and training, most services provided by doctors and dentists, postage and fundraising events by charities.
- Outside the scope of VAT – Some transactions are outside the scope of VAT. For example dividends, shares of profit compensation for losses and non UK supplies.
On a periodic basis you have to report the value of your sales to HMRC, the VAT you charged on these, the value of goods and services you bought, and the VAT you were charged.
At it’s simplest you then take one away from the other and pay over, or reclaim the balance.
There is additional information and complexity unfortunately also if you do any trade, selling or buying, elsewhere within the EU.
You need to know all these rules, and the 4 different treatments above, to make sure you report the right information.
My business is small, is there an easier way?
For smaller businesses there are a couple of special schemes that are designed to make the administration a bit easier. These are the cash accounting and the flat rate schemes. There are also special schemes of accounting for VAT for retailers.
How often do I have to do this?
VAT returns have to be filed at least every quarter, and if you expect to get refunds every time then you may choose to submit returns monthly so that you get your money back faster.
You must report the VAT information within one month after the end of the VAT period and that is when you pay or get paid any VAT owed.
If you file your return online you get an extra 7 days to submit the return, and if you pay by direct debit you get another 3 days before the payment is processed.
Make sure your invoices are correct
The last bit of advice is to make sure that your invoices, and the purchase invoices you receive, contain the correct information as this can determine what tax you might owe.
A tax invoice is required to show:
- A unique invoice number which is sequential and based on one or more series
- The date of the invoice, and the date of supply if this is different from the invoice date
- The name, address, and VAT registration number of the supplier
- The name and address of the customer to whom the goods and services are supplied
- A description that is sufficient to identify the goods or services supplied
- For each description the quantity of the goods or the extent or nature of the services, a unit price, the rate of tax, and the amount payable, excluding tax
- The total amount payable excluding tax
- The rate of any cash discount offered
- The total VAT payable.
There is no requirement to issue a tax invoice for a zero-rated or exempt supply. However, you might want to issue some form of invoice for either type of supply to establish that VAT is not chargeable on it.
Copies of all tax invoices issued and received must be retained for at least six years.
On the basis that the general public are unable to reclaim any VAT charged to them they may not worry about getting a full invoice and a business does not have to supply a tax invoice unless the customer requires one.
If the consumer does request an invoice, where the tax-inclusive value of supply is not more than £250, the supplier may issue a simplified form of invoice giving only the following details which is why basic till receipts comply with the legislation:
- Name, address and registration number of the retailer
- Date of supply
- A description, adequate to identify the goods or services supplied
- The total amount payable including tax
- The rate of tax at the time of the supply.
It’s all too much I give up!
You can de-register for VAT when anticipated turnover for the next year (measured from any time) is less than the threshold.
Think carefully though as although there can be lots of admin, depending on what you do, there can be financial benefits for being VAT registered even if you are below the limit.
Finally, you must de-register when taxable supplies are no longer made. In other words when your business ceases to trade.
Before You Go …
You may find this video helpful when deciding whether you should register for VAT if you don’t legally have to
If and when you begin employing someone you will need to operate a Pay As You Earn (PAYE) scheme. Check out our next article where we give an overview of this tax.
