The ‘should I, or shouldn’t I’ VAT dilemma

Strictly speaking, you don’t have to register your business for VAT until you reach the turnover threshold of £85,000 per 12-month trading period. And, turnover means your total sales, not profits, so a start-up business can quickly become liable.

What every new business needs to know about VAT

However, you can, if you wish, register for VAT before you reach the threshold.

This ‘should I, or shouldn’t I’ dilemma often causes confusion for new business owners and is an area of business knowledge that we’re frequently asked to explain.

What exactly is VAT all about?

VAT stands for value-added tax and was first introduced on April Fool’s Day 1973. The current legislation which determines today’s rules is the 1994 Value Added Tax Act.

VAT is a tax added to goods and services on behalf of HMRC by the businesses that sell those goods and services. Essentially, a VAT-registered business is simply collecting VAT to pass on to the Government. VAT is levied on most goods and services provided by VAT-registered businesses in the UK and on some that have been imported from outside the UK.

When you register your business for VAT, you add VAT (currently 20% standard rate on most goods and services) to the price you charge the consumer. This portion of the tax is itemised and identified separately on the invoice or receipt so the consumer knows how much the item cost, and how much tax has been paid.

Let’s be clear, the VAT portion of the cost of the goods and services paid by consumers never belongs to the business, it belongs to the Government and is collected by HMRC.

On the other side of the equation, VAT-registered businesses can reclaim from HMRC any VAT they have paid on the goods and services they have bought such as raw materials, ancillary services and other costs.

If you’re not VAT registered, you still have to pay VAT on your business purchases, but cannot reclaim it.

The case for delaying registration

Many businesses delay registering for VAT as long as possible because adding VAT to their prices makes them look more expensive and less competitive than other businesses selling the same or similar goods.

This especially applies to businesses that sell primarily to non-VAT registered individuals who cannot claim the tax back. This is a particular consideration for small business owners such as tradespeople, artisan makers and freelancers.

VAT creates more work, and has to be managed, calculated, declared and paid. That also means extra costs for bookkeeping and accounting services, although there are features within digital accounting packages that do most of the basic number crunching for you.

Late, or non-payment of VAT is serious and can result in criminal proceedings being taken against the Directors or owners of the business.

The case for voluntary registration

If your business sells primarily to other businesses that are also VAT registered, you could benefit from registering for VAT as soon as possible. This mechanism also helps to avoid you looking ‘expensive’ as compared to other non-VAT registered suppliers, as your customers can claim the tax back themselves.
When your business is looking to invest in expensive assets such as plant or machinery, being VAT registered means you can claim the VAT back on those purchases.
If your VATable costs are higher than your VATable sales, you’ll cut your costs by being VAT registered. This can happen when you buy stock that doesn’t get sold for some time to come, or when your sales carry a lower VAT rate than the 20% rate you’ve paid for the raw materials (a reduced rate of 5% or zero-rated goods).
Some businesses and brands must appear to be bigger or running a higher turnover than they actually are, being VAT-registered can help create this impression.
You may be able to reclaim the tax you’ve paid on goods you bought for the business before you registered for VAT. Your accountant will advise you.
The current rules state that you must register for VAT within 30 days of your turnover reaching the VAT threshold of £85,000 in the preceding 12-month period. You must also register if you expect to reach the threshold in the next 30 days. If you don’t register when you should, you’ll be liable for the back VAT from the date your registration should have been made. You may also be liable for added interest.

Here’s an example of how being VAT-registered could benefit your business:

If your income is £100,000 and your costs are £48,000, you would have a profit of £52,000.

Suppose you register for VAT, you would then have income of £120,000, of which £100,000 is yours and £20,000 is VAT collected on behalf of HMRC.

If your £48,000 includes £4,000* of VAT, then you pay HMRC £20,000 – £4,000 = £16,000.

That reduces your costs by £4,000 to £44,000

Your profit is then £100,000 – £44,000 = £56,000, so you are better off by the £4,000 of VAT that you are now able to reclaim from HMRC.

*Not all costs include VAT (e.g. there is no VAT on salaries or bank charges).

Not all VAT is equal

Just when you’re getting your head around this, there are more complications. There are, in fact, four different forms of VAT accounting schemes, one of which will be most suitable for your business.

All four have pros and cons, and your accountant or tax adviser will be able to guide you as to your best option:

Standard Accounting: You submit quarterly VAT returns and any VAT owed or reclaimed is paid quarterly. This is based on invoiced sales and purchases, so if you’ve paid for goods, but your customer hasn’t yet paid you, you still owe the due VAT, which could cause cashflow problems.
Cash Accounting: VAT is due at the end of the quarter after you’ve been paid, rather than the invoice date. The same applies to reclaiming the VAT on purchases, which could be a problem if you’ve paid for the goods on credit.
Annual Accounting: You pay VAT in nine monthly instalments throughout the year based on last year’s payments (or an estimate if you’ve been in business less than 12 months). You complete an annual VAT return, and any overpaid VAT is rebated to you, or you pay the shortfall balance, according to how the figures work out.
Flat-rate Scheme: This can apply to VAT-registered businesses with less than £150,000 turnover. You pay VAT as a fixed percentage of your gross turnover (including VAT). Different percentages are depending on the industry you operate in.

https://www.gov.uk/how-vat-works/vat-schemes

How to voluntarily register for VAT

The process is the same regardless of whether your registration is voluntary or compulsory. You register directly with HMRC or can use the form VAT1. Your accountant will take care of the details for you. Once registered, you will receive your VAT registration certificate from HMRC within 14 days.

https://www.gov.uk/register-for-vat

You can de-register for voluntary VAT under specific circumstances. Speak to your accountant or tax adviser.

Making Tax Digital

From 1 April 2022, anyone registered for VAT (including those who registered voluntarily) will need to comply with Making Tax Digital.

https://www.gov.uk/government/collections/making-tax-digital-for-vat

As with any area of business finance, there are specific rules, dates, thresholds and ways of operating within the rules. You should consult with a qualified tax adviser or accountant before deciding on the best route for your business.