VAT explained

If your business is registered for VAT you are obliged to act as a collector of tax. You charge VAT at 20% on the services you provide and pass this on to HM Revenue & Customs. Before passing it on you are allowed to deduct any VAT that you have been charged by other businesses.

One of the first questions that new business owners ask is should they register their business for VAT. If your turnover in any 12 month period exceeds £85,000 then registration is mandatory. If it is not you may choose to register voluntarily if you wish. However, following recent changes to the VAT flat rate scheme categories, it is no longer our advice that a company automatically opts for VAT registration. You should consider this option carefully and whether the benefits in your situation are likely to outweigh the administrative cost.

What are the benefits of being registered?

If you are registered for the standard scheme you can recover any VAT that has been charged to you.

There is an alternative scheme called the Flat Rate Scheme which, prior to April 2017, produced an even higher recovery of VAT. However HMRC have introduced a new category for limited cost traders, which means that in most cases the flat rate scheme no longer produces a better financial return than the standard scheme (although it does still have the advantage of being simple to operate).

Apart from the financial benefits, being registered for VAT can help promote your business, presenting an image of a large, professional and well established organisation.

How do I register?

Registration is completed online and Competex will handle all aspects of this for you as part of the set up process. This includes registering for the flat scheme (if appropriate). We would also encourage you to set up a direct debit so the VAT calculated each quarter is automatically paid to HMRC on the due date following your submission of the VAT return.

When is VAT payable?

We register our clients to report VAT on a quarterly basis using the standard quarter ends of 31 March, 30 June, 30 September and 31 December. Returns have to be submitted online around 5 weeks later; by the 7th of May, August, November and February. Any VAT due also has to be paid by these dates although direct debit payments are taken a few days later.

In what circumstances might voluntary registration not be advisable?

If your clients are not VAT registered themselves, for instance maybe they are a charity, then they would not be able to reclaim the VAT you charge them. Therefore they may pay you a better rate if you are not VAT registered.

If the majority of your work is carried out outside the UK then there may be a limited amount of VAT on purchases and expenses incurred in the UK for you to recover. Foreign VAT incurred cannot be recovered through the UK VAT system although you can make a separate online claim for VAT incurred in EU countries (probably only worth doing if it is significant).

If you are certain your annual turnover will be below £85,000 then you might not want the additional administrative burden of recording all VAT collected and incurred, and filing quarterly returns.

Note that if you choose NOT to register for VAT, you must monitor your turnover on a rolling 12 month basis and advise us as soon as you think you may exceed £85,000, so we can apply for VAT registration. There are penalties for not doing so within 30 days.

What is the flat rate scheme?

HMRC introduced this scheme to make accounting for VAT simpler. You still have to charge VAT on all the work you do for UK businesses but you cannot recover the VAT you have been charged (and therefore you do not have to record the VAT you have incurred on purchases and expenses, which saves a lot of extra analysis). Instead you apply a reduced percentage to your gross sales income and pay this amount to HMRC. There is a list of different business sectors, from which you select the most appropriate to you, and each sector has a set percentage that must be applied to gross sales.

From April 2017 we expect that the majority of our clients are likely to fall within the limited cost trader category for which the rate is 16.5% (15.5% in first year of registration). A limited cost trader is one who spends very little on qualifying goods which, for consultants, is likely to mean stationery, books and certain software (hard format not downloaded). Capital items like laptops are excluded as ‘goods’ and all services such as travel and subsistence are also excluded.

HMRC have provided the following further examples of goods that are specifically excluded:

  • Accountancy fees, these are services
  • Advertising costs, these are services
  • An item leased/hired to your business, this counts as services, as ownership will never transfer to your business
  • Food and drink for you or your staff, these are excluded goods
  • Fuel for a car this is excluded unless operating in the transport sector using your own, or a leased vehicle
  • Laptop or mobile phone for use by the business, this is excluded as it is capital expenditure
  • Anything provided electronically, for example a downloaded magazine, these are services
  • Rent, this is a service
  • Software you download, this is a service
  • Software designed specifically for you (bespoke software), this is a service even if it is not
    supplied electronically

You’re a limited cost trader if the amount you spend on relevant goods including VAT is either:

  • less than 2% of your VAT flat rate turnover
  • greater than 2% of your VAT flat rate turnover but less than £1000 per year

If you are not a limited cost trader you can apply and use the appropriate business category rate rather than 16.5%. This assessment should be carried out on a quarterly basis and the appropriate rate applied each quarter.

If your agreed flat rate is 16.5% and you invoice your client for fees of £10,000 (plus £2,000 VAT), the VAT payable to HMRC will be £12,000 x 16.5% = £1,980.00. This means that you retain £20 of VAT.

The scheme is only available to businesses who forecast their taxable net turnover will not exceed £150,000 in the subsequent 12 months. Taxable turnover excludes VAT and supplies of services made to businesses outside the UK. Once you have joined you have to check your level of turnover each year and will usually be required to leave the scheme if this exceeds £230,000 over the past 12 months. For these purposes both VAT and supplies made to businesses outside the UK are included in the turnover calculation.

The flat rate scheme is usually not suitable if you incur a high level of VAT on expenses (perhaps because you use sub-contractors) or if most of your work is for businesses outside the UK. Comprehensive information can be found on the link below to Flat rate VAT notice 733.

Read our handout on the VAT Flat Rate Scheme (FRS)

Which scheme is best for me?

As mentioned above, generally the Standard rate scheme will produce a better financial return than the Flat rate scheme. However, in the first 12 months of VAT registration it may be worth considering joining the flat rate scheme because the savings could be more than the VAT you would recover under the Standard rate scheme. There could of course be situations where this is not the case, such as if you are going to hire sub-contractors, and therefore you will have a substantial amount of VAT incurred which you want to recover. You should assess the amount of VAT you think you will incur and compare this to the savings using the Flat rate scheme.

Here are some examples to help illustrate the comparable savings from the two schemes, under different scenarios:

Note that with the flat rate scheme you may still recover VAT incurred on the purchase of capital assets where the invoice value is £2,000 or more including VAT. This is the one exception where you can recover VAT incurred whilst using this scheme.

Can I reclaim VAT on pre-registration expenses?

Provided the expense or item was originally incurred or purchased specifically for the business then you can recover the VAT incurred on goods up to 4 years prior to registration and on services up to 6 months prior. This means that if you bought a laptop for personal use 2 years ago, before your business existed, you cannot recover the VAT if you transfer it to the business 2 years later.

However, you could recover the VAT on a laptop purchased 2 weeks before the business was incorporated or registered for VAT, provided it was purchased specifically for the business. Any VAT recoverable on pre-registration expenses has to be recovered on your first VAT return and the software we use will work this out for you.

If you choose to join the flat rate scheme you can still recover any VAT incurred on pre-registration expenditure.

What do I need to consider if my clients are outside the UK?

If your customer is based outside the UK, and that customer is a business rather than an individual, then the supply is generally deemed to be where the customer is based. This means that the supply is outside the scope of UK VAT and therefore no VAT should be charged on your sales invoices.

There are a few exceptions to this such as services related to land and property, including architects and surveyors, and some services related to events. In these cases the place of supply is where the land is or where the event is performed. There are also special rules for telecommunications and digital services.

Are EC sales treated differently to non EC?

If you make a supply to an EU country then responsibility for accounting for VAT passes to that business. This is called the reverse charge mechanism. All you need to do is make sure your sales invoice includes the client’s VAT registration number (this proves they are a business), as well as your own, and also includes something like ‘supply is subject to the reverse charge – customer to account for the VAT’. Apart from this there is an additional HMRC reporting requirement called an EC sales list. You will need to register separately online for this and provide details of all such sales on a quarterly basis, within 21 days of each quarter end.

You need to get it right

The penalties for late submission of a return or late payment of VAT are quite harsh. However, HMRC will allow you to be late at least once in every 12 month period before they start to impose surcharges. Penalties for deliberate or careless inaccuracies can be up to 100% of the VAT due, but provided you are using a reliable software accounting package any errors should be minimal.

For further advice on any aspect of VAT please contact the team at Competex.

Amy FowlerVAT explained