If your business is just starting to grow and only now picking up customers based in Europe, you may not have hit the VAT (Value Added Tax) threshold yet. Would it still be prudent to register for VAT early? And if you decide to do so, which VAT scheme best fits your business?
The default rate for VAT is 20% for all goods and services. In practice, it becomes a lot more complex than simply applying that percentage across the board. You need a clear understanding of both the opportunities and risks open to your business in the way you manage VAT.
This article will do its best to give you the understanding you need to make smart VAT choices.
What Is The UK Business Threshold For VAT?
At present, the UK's VAT registration threshold is set at £85,000. You must register for VAT if your business's annual turnover is higher than that figure.
The VAT threshold is not set in stone. The £85,000 figure took effect in April of 2017; prior to that, the threshold was £83,000.
Your business has a 30-day grace period to register for VAT after your turnover exceeds the threshold. If your turnover crosses the mark on September 30th, for example, you have until November 1st to register. Failure to register within this period can open you up to a fine imposed by HMRC.
What VAT Rate Does My Business Need To Pay?
As noted above, the standard VAT rate applying to most goods and services is 20%.
Certain goods and services qualify for a reduced VAT rate of 5%. Examples include:
* Energy and power
* Car seats for children
* Home mobility aids for people over 60
There is also a zero VAT rate applied to some goods and services. If the 0% rate applies to your business, you still need to charge your customers, keep VAT records, and complete a VAT return. The zero rate applies to:
* Most food items
* Children's clothes (including shoes)
* Motorcycle helmets
* Books and newspapers
* Most export goods sent to non-EU countries
* Goods supplied to an EU business registered for VAT. VAT numbers can and should be checked for validity
Picking The Right VAT Scheme
Tracking VAT properly obliges you to keep current records of every purchase and sale your business makes. Most modern accounting software is capable of isolating and recording the data needed for VAT record-keeping automatically. As of April 2019, HMRC Making Tax Digital for VAT scheme will come into effect. This makes the use of a compliant software package absolutely necessary. The days of tracking VAT data on paper records are over.
Your business's VAT records provide the data you need to file a VAT return. If your business did more purchasing than selling, you may be entitled to receive a refund.
Businesses can choose from a few alternative VAT schemes:
* Annual Accounting VAT Scheme
As the name suggests, this scheme's primary feature is allowing you to complete VAT returns on a once-per-year basis. Your business is eligible for the annual accounting scheme only so long as its estimated turnover (taxable) is under £1.35m. You are obliged to leave the scheme if your turnover grows beyond £1.6m.
* Flat Rate VAT Scheme
Smaller businesses are eligible for this scheme wherein you pay a percentage of your total turnover to meet your VAT obligations. The flat rate scheme is open to businesses with an annual turnover of no more than £150,000.
This scheme imposes a different rate depending upon your business’s industry. While you still need to charge VAT when you invoice with this scheme, you do not need to track VAT information for your purchases.
The flat rate VAT scheme allows for a significant amount of business growth. You may remain in the scheme until the total income for your business exceeds £230,000.
Using the flat rate scheme during the first year you register your business for VAT entitles you to a one percent discount.
* Cash Accounting VAT Scheme
The key to this scheme is that you conduct your VAT accounting on the date you receive payment instead of the date you send invoices. Obviously, you will need to include actual payment dates in your VAT records.
The cash accounting scheme is tremendously useful for businesses which deal with slow payers. It's also useful for professional firms which receive payments more often than they invoice, e.g. a design agency that invoices annually but takes payment monthly.
Businesses unsuited to this scheme include those that buy heavily on credit and do not extend credit to their customers. Reclaiming VAT under this scheme is impossible until payments are completed. Like standard VAT accounting, you are obliged to complete VAT returns on a quarterly basis with this scheme.
The cash accounting scheme is available to businesses with an annual turnover of less than £1.35m. If you overpay your vat you can refund VAT.
* Retail / VAT Margin Schemes
VAT retail schemes simplify your VAT calculations. They allow you to calculate VAT on a holistic basis on each return rather than calculating it for each sale individually.
This scheme suits businesses that handle second-hand goods, such as fine art and antiques.
Similar schemes are offered for businesses of different turnover levels. One scheme covers businesses with retail turnover (excluding VAT) under £1m; another covers businesses with turnover between £1m and £130m. Retailers with turnover greater than £130m can coordinate with HMRC to arrange a bespoke scheme.
VAT retail schemes are compatible with cash or annual accounting schemes for smaller retailers. Retail schemes cannot be combined with the flat rate VAT scheme.
Voluntary VAT Registration
You are free to register your business for VAT even if your turnover does not yet meet the current registration threshold.
This step has potential advantages and drawbacks. Some of the benefits include:
* Potential 'input vs output' savings. In a situation where you know your business is going to pay more VAT than it collects, registering for VAT enables you to collect the difference back from HMRC. A common example is a startup business paying high VAT on necessary equipment (the 'input tax') and collecting lower VAT from customers (the 'output tax').
* Registering for VAT removes the impression that you are running a micro business. Registering early demonstrates your confidence in growing your business and may, in turn, earn the trust of prospective clients/customers.
* Registering for VAT does not affect your customers if most or all of them are other VAT-registered entities.
The potential drawbacks of early VAT registration include:
* You may increase your tax obligation if your output tax exceeds your input tax. Remember, input tax is what your business pays on the goods and services it consumes and output tax is what you collect from your own customers. You will need to pay more to HMRC if you collect more than you pay.
* VAT registration requires you to track all invoices and receipts. This is much less of a burden with modern accounting software, but it may still be a hassle.
Reasons To Avoid Early VAT Registration
The single most common reason to postpone VAT registration as long as possible is if you don't sell to many other VAT-registered businesses. Businesses that serve the general public, for example, want to avoid VAT registration for as long as possible. Once you are registered for VAT and your customers are not, you have to decide whether to absorb the additional cost yourself or pass it along to your customers.
VAT And The Making Tax Digital Initiative
The Making Tax Digital Initiative is an HMRC scheme that will oblige VAT-registered businesses to keep all of their VAT records digitally after the 6th of April 2019. VAT returns need to be created and submitted digitally. After the initiative comes into effect, VAT returns will no longer be accepted by post or with the HMRC online service.
The good news is that many of the common accounting software packages in use in the UK are already compliant with the Making Tax Digital Initiative. Examples include Xero, Sage, and Quickbooks.
Making The VAT Registration Decision
Registering for VAT is not a complicated process; you can easily complete all the necessary steps online. We strongly recommend consulting with an accountant before taking this step, though. Registering for VAT early or choosing the wrong scheme may have significant drawbacks that you could easily avoid with basic professional advice.
Charlotte Lewis has worked for a variety of different businesses over the years and has taken a big interest in social media in the last 3 years. She is a content marketer and social media consultant.
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