Facts you should know: VAT Basics For Business Owners

VAT Basics For Business Owners


Because many business owners start their enterprises off below the registration threshold for value added tax (VAT), they lose sight of their obligation to register as their business grows. The shift to charging and paying VAT can be a nasty shock for unprepared owners. Clive Lewis, ICAEW’s head of enterprise, delivers a “back to basics” guide on the fundamentals of VAT. This should be useful to any business owner approaching the registration threshold.


VAT Defined


VAT was first developed in France in the 1950s. It was soon incorporated into the European Common Market and then became a requirement for the European Union, and it is now obligatory for all member countries. Registering your business for VAT is necessary before you can begin charging for it on the goods or services you sell. VAT is added to a wide range of transactions, including:


* Selling goods or providing services (commonly referred to as “business sales”)

* Commissions

* Sales of assets

* Goods sold to staff members, e.g. meals provided in a canteen

* Business goods re-purposed for personal use

* “Non-sale” transactions like gifts, exchanges, and bartering


VATGlobal says that registering your business for VAT obliges you to report your collection and payment of VAT to HM Revenue and Customs (HMRC).


The VAT Threshold


Any business with an annual turnover of more than £83,000 must register for VAT. This was the threshold for the 2016/17 tax year; it is regularly changed. Check with HMRC for the latest threshold figures. If your business’s turnover hasn’t yet reached the registration threshold, you can still register at-will.


How Does VAT Work?


Every sales invoice issued by a registered business must include VAT. VAT is added to purchase invoices if the supplier is also a VAT-registered business. Every invoice involving VAT needs to include key information, most importantly the VAT registration numbers of the businesses involved. The standard rate for VAT is currently set at 20%, which applies to most items and services. A few specially-defined items are eligible for reduced VAT (five percent) or are zero-rated (no VAT charged).


Zero-Rated Items


Goods and services that are exempt from VAT are called zero-rated. The VAT system has its share of irregularities, and some unexpected items can fall into the zero-rated category due to the way the categories are defined. Definitional disagreements sometimes bring businesses into conflict with HRMC.


The most famous example is the Jaffa Cake, which needed to have its definition defined by a tribunal. Luxury biscuits are subject to standard VAT, but cakes are zero-rated. McVities, the firm that makes Jaffa Cakes, made a strong case for their product being a cake rather than a biscuit, and this view eventually prevailed with the tribunal.


VAT Returns


As mentioned above, record-keeping is the chief obligation for VAT-registered businesses. Businesses submit quarterly VAT returns to HMRC, a process which is now carried out electronically. Input taxes (paid on purchases) are subtracted from output taxes (charged on sales), and the difference is paid to HMRC. There are several different payment options available. Businesses that report paying more input tax than they collect in output tax receive repayments from the HMRC to cover the difference.


Alternate VAT Schemes


Businesses can take advantage of a range of alternative VAT schemes. Some of these are particularly suited to the needs of retail businesses that sell to the general public.


Cash Accounting Scheme (aka Receipts & Payments)

* This scheme calculates the tax due to HMRC from receipts and records of payments made to suppliers rather than from invoices.

* This scheme suits businesses with cash-flow issues or debt issues.

* A business’s VAT-taxable sales must be less than £1,350,000 to qualify for this scheme.


Annual Accounting Scheme

* A business pays on installments (monthly or quarterly) based on estimated liability or records of VAT paid in previous years.

* This scheme obliges the business to submit only one VAT return per year.

* All the same records must be maintained for potential use in VAT inspections.

* This scheme is poorly-suited to businesses that usually reclaim VAT, as all repayments from HMRC are made on an annual basis.

* A business’s VAT-taxable sales must be less than £1,350,000 to qualify for this scheme.


Flat Rate Scheme

* Businesses in this scheme do not need to record VAT on a transactional basis.

* Instead, a flat percentage of turnover (based on sector figures) is paid as VAT.

* Because this is a net input tax, the percentage is lower than the standard VAT rate.

* A business’s annual turnover (excluding VAT) must be less than £150,000 to qualify for this scheme.


VAT On Overseas Sales


Businesses that provide digital services to customers in other EU countries have two options to fulfill their VAT obligations in the customers’ country. They can either register for VAT in the EU state where their customers are located or complete a UK VAT MOSS scheme. This allows the business to make quarterly returns and payments to HMRC as usual and shifts the burden of distributing the collected tax to other VAT authorities to HMRC.


This is a relatively recent development caused by a regulatory shift that prioritized customers’ VAT rules over suppliers’. The change first took effect at the start of 2015. Plans are in motion to extend the scheme to all goods and services from 2018.

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