If you’re running a small business, you’ve probably encountered the term VAT and may be wondering what it means for your operations. Value Added Tax (VAT) is a crucial part of the UK tax system, impacting businesses across all sectors.
Whether you’re new to self-employment or considering VAT registration, understanding how it works, the benefits, and the various schemes available is essential.
Let’s break down all the main points you need to know about VAT in the UK, ensuring you can stay compliant while making informed decisions that can positively impact your business.
Don’t have time? Here’s the wrap-up of this article in less time it takes to eat a taco 🌮
▪ VAT is a tax on consumer expenditure, paid by the final consumer.
▪ The standard VAT rate is 20%, though some items are zero-rated or exempt.
▪ Inside IR35 means you’re taxed like an employee, while outside IR35 offers more tax efficiency.
▪ VAT-registered businesses must file quarterly VAT returns. (OMB Connect Pro Tip: You can choose to file monthly or annually)
▪ Voluntary registration has benefits, even if your turnover is below the £90,000 threshold.
▪ Different VAT schemes can be chosen based on your business needs, such as the Flat Rate Scheme or Cash Accounting.
n.b. Stay Sharp, Stay Savvy and Keep Winning.
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What is VAT?
1- From Business Owner to Zacchaeus (from the Bible)
Here’s the not so hot take: VAT registered businesses are the unpaid tax-collectors of HMRC. At least Zacchaeus got paid!
VAT (Value Added Tax) is a tax on consumer expenditure that is collected at each stage of the supply chain.
While businesses charge VAT on goods and services, it is the final consumer who bears the tax. Businesses, especially those VAT-registered, act as intermediaries, collecting VAT from their sales (output VAT) and reclaiming VAT on purchases for their business (input VAT).
VAT is levied at different rates depending on the nature of the goods or services:
▪ Standard Rate: 20% (applies to most goods and services)
▪ Reduced Rate: 5% (e.g., some home energy products, children’s car seats)
▪ Zero Rate: 0% (e.g., basic foodstuffs, books, children’s clothing)
▪ Exempt: No VAT applied (e.g., financial services, education, insurance)
VAT was introduced in 1973 and continues to play a critical role in how businesses interact with taxation. For most VAT-registered businesses, the responsibility lies in correctly calculating, charging, and remitting VAT to HMRC (HM Revenue & Customs).
2- When is VAT Charged?
For a transaction to be subject to VAT, it must meet certain conditions:
1- Taxable Supply of Goods or Services: This means the item in question is not exempt from VAT.
2- Made in the UK: The supply must be made within the UK.
3- By a Taxable Person: The business must be VAT-registered.
4- In the Course of Business: The supply must be made to generate business income.
If a supply meets all these conditions, VAT will need to be charged. However, if it fails to meet any of these, it may fall outside the scope of UK VAT.
3- VAT-Registered Businesses and VAT Returns
Once your business becomes VAT registered, you’ll be required to submit quarterly VAT returns to HMRC. These returns show how much VAT you’ve collected from your customers (output VAT) and how much VAT you’ve paid on business purchases (input VAT).
The difference between the two determines whether you owe HMRC or are due a refund. If your input VAT exceeds your output VAT, HMRC will refund the difference.
4- Benefits of VAT Registration
Many small businesses view VAT as an administrative burden, but there are several compelling reasons to register voluntarily, even if your turnover is below the mandatory £90,000 VAT threshold:
▪ Professional Perception: Being VAT-registered can boost your business’s credibility. Other companies and suppliers might view your business as more established and trustworthy if it’s VAT-registered.
▪ Reclaiming VAT: If your business makes significant purchases, registering for VAT allows you to reclaim VAT on goods and services purchased for the business. This can lead to a significant cash benefit, especially for companies that have high upfront costs.
▪ Improved Cash Flow: By charging VAT on your sales, your prices will increase by 20%, boosting cash flow. Meanwhile, you can claim back VAT on purchases made for the business.
5- VAT Exemptions and Zero-Rated Goods
Some businesses might be VAT exempt, meaning they don’t need to charge VAT on their products or services. However, this also means they can’t reclaim VAT on their own purchases. Common examples of VAT-exempt sectors include education, financial services, and insurance.
It’s crucial to differentiate between VAT exempt and zero-rated items. While neither has VAT added, zero-rated goods still count towards your taxable turnover and must be included in VAT returns.
6- What VAT Scheme is Right for Your Business?
Once you decide to register for VAT, you’ll need to choose the most appropriate VAT scheme for your business.
Here’s a breakdown of the most common options:
1. Standard Rate VAT Scheme
This is the most common VAT scheme, where VAT is charged at 20%. You calculate your VAT liability as the difference between the VAT collected on sales (output VAT) and the VAT paid on purchases (input VAT).
2. Flat Rate VAT Scheme (Read more about the Flat Rate Scheme here.)
Designed to simplify VAT for small businesses, the Flat Rate Scheme lets businesses pay a fixed percentage of their turnover in VAT. The rate varies depending on the sector but typically ranges from 4% to 14.5%. While this simplifies VAT calculations, it also means you can’t reclaim VAT on most purchases.
3. Cash Accounting VAT Scheme
This scheme helps small businesses manage cash flow by allowing VAT to be paid only when customers settle invoices, rather than when invoices are issued. VAT on purchases can only be reclaimed when payment has been made. To qualify, your turnover must be below £1.35 million.
7- VAT and Tax Efficiency
Understanding how VAT works can help businesses save money. VAT-registered businesses can recover input tax on goods and services, and through strategic planning—like timing significant purchases for when VAT returns are due—you can better manage your cash flow and liabilities.
Additionally, being VAT-registered provides tax-efficient opportunities when combined with other forms of tax planning, such as leveraging allowable expenses and making pension contributions through the business, both of which offer Corporation Tax relief.
Conclusion: VAT and Your Business
VAT might seem complicated, but understanding it can bring significant benefits to your business. From boosting your professional image to improving cash flow and offering opportunities for tax planning, VAT registration—voluntary or mandatory—could be a strategic move.
Here’s the plug 🔌
VAT can be complex. ‘No shizer, Sherlock!’
Our mission is to break down the silos and bridge the financial literacy gap. We plan to grow this blog and give away everything you could possibly need to know. Through OMB Connect’s dedicated courses, we walk you through real life examples of registering, setting up, and managing VAT. From connecting MTD with your accountancy software to bookkeeping and filing you own VAT returns.
This ain’t a disruption. It’s a revolution.
Are you in, or are you in?