VAT is often cited as one of the most burdensome business taxes, but once you reach the HMRC threshold there is no escaping the taxman.
The tax is essentially a charge on non-essential consumption, but eligible businesses need to tell HMRC both how much of it they are spending and receiving through a VAT return.
This can be time consuming but there are some tax benefits.
So what does a VAT-registered business have to do?
What is VAT?
VAT or value added tax, is a charge on services or products seen as discretionary or non-essential.
Any limited company or sole trader with taxable turnover of more than £83,000 needs to register for VAT.
This can be done on the HMRC website and you will receive a registration certificate, VAT number and details of when to submit your first VAT return.
You can also register voluntarily if your turnover is less than £83,000, this can be beneficial if you make lots of sales to VAT registered-businesses as you will be able to reclaim your costs.
You can apply for an exemption if you can provide evidence to HMRC that you are only temporarily going over the threshold.
If you are registered for VAT you must file a return every three months and usually need to pay at the same time. You must ensure any funds you send will clear by the deadline.
Any late payment or filing will be categorised as a ‘default’ by HMRC, meaning interest could be charged.
First-time offenders don’t have to pay if they have not defaulted before.
But after that you could see interest of between 2 per cent and 10 per cent depending on how many defaults there are in 12 months.
There are exceptions if your return is late but your payment is on time or if there is no tax to pay.
Your VAT return essentially looks at how much VAT you have charged and how much you have paid. The difference is what you would owe HMRC.
There are three main rates of VAT that you are likely to charge or pay.
Most goods and services are charged at the standard rate, currently 20 per cent.
There is a reduced rate of 5 per cent on items such as fuel or children’s car seats. There is also a zero rate on children’s clothing and shoes.
A VAT-registered business must charge VAT on all their goods or services and can reclaim it on business-related goods or services.
Once you are registered for VAT you can join either the standard or flat rate scheme.
Under the standard scheme you reclaim the VAT manually for every item purchased and sold during your reporting year.
Alternatively, if your turnover is under £150,000 you can join the flat rate scheme. This allows businesses to reclaim a sector specific rate based on their turnover.
For example, if you were an IT consultant you could charge a client 20 per cent VAT, but the flat rate for HMRC is only 14.5 per cent, so you could keep the difference.
Choosing between the standard and flat rate scheme depends on how you run your business. If you have a lot of costs it may be better to use the standard rate as you can reclaim more.
There are also two different ways of accounting for VAT. You can either use cash or accrual accounting.
If you have high but irregular sales, as might be the case for a consultant, you would take the cash scheme because you only pay the VAT once you’ve received the cash rather than from the date of the invoice.
Alternatively, if you work somewhere like retail, where you get the cash instantly, If you may prefer accrual accounting because you can reclaim the VAT on your supplier invoices before you’ve actually paid them.