Value-added tax (VAT) is a consumption tax that’s levied on goods that have had value added at each stage of the supply chain.
Most businesses with annual sales of £85,000 or more have to register for VAT. And even if your sales are below that level, you can register on a voluntary basis. VAT can be confusing, though, with different rates, options and, in some cases, quite complex rules to consider.
So, is your business likely to be required to pay and collect VAT? And why do we have VAT in the first place?
1. The key requirements for a VAT-registered business
In essence, VAT should be a simple form of taxation. As a VAT-registered business, you must:
- Charge VAT to your customers
- Deduct VAT you have been charged by your suppliers
- Pay the difference over to HMRC (or claim it back if there’s a refund).
- Sometimes people believe that, cosmetically speaking, they appear bigger or more successful if they’re VAT registered, and that alone is enough to persuade some people.
- Secondly, if most of your customers are themselves VAT-registered, then the VAT you charge isn’t a real cost to them, and you can benefit from reclaiming VAT incurred on your own purchases. Because of this, you can make more profit as a VAT-registered business that otherwise would be lost to tax.
- On an invoice basis, you include VAT on sales based on your invoice dates, and deduct VAT charged by your suppliers based on their invoice dates.
- On the cash basis, the relevant dates are when your customer pays you, and when you pay your supplier.
- The standard rate of 20% applies to most goods and services.
- The reduced rate of 5% applies to domestic gas and electricity, and to supplies in the construction industry, such as certain building renovations and alterations. It also applies to some energy-saving materials installed in residential properties, to child car seats and some mobility aids. The reduced rate has been temporarily extended to some aspects of the hospitality industry over the course of the pandemic.
- Zero-rate (0%) applies mainly to everyday items, like basic foods, children’s clothing, books and newspapers etc.
- There is another category, which is called ‘exempt’. This is where no VAT is charged, but the business supplying it cannot reclaim any VAT they incur in respect of such supplies. This includes items such as postal services and health services.
- Goods, services and materials to be incorporated into things you sell
- Expenses such as stationery and telephone charges
- Most capital purchases, such as computer equipment and commercial vehicles.
- Decide whether or not you should register voluntarily
- Run a ‘health-check’ of your systems if you’re already VAT-registered
- Make sure you’ve considered any of the applicable special VAT schemes.