Business VAT explained
VAT, or value added tax to give it its full name, is a tax paid to the government when goods or services are sold.
The law requires all businesses over a certain size to register for VAT. So if you’re at that stage, congratulations – it means you’re going up in the world! If you’re not there yet, you probably soon will be. Either way, read on to find out all you need to know …
Registering for VAT
If your turnover is more than £85,000 a year, you have to register for VAT with HMRC. This means you need to charge VAT on the goods and services you sell, and pay VAT on the goods and services you buy.
Every three months, you send HMRC a VAT return telling them all the VAT you’ve paid, and all the VAT you’ve charged. The idea is that they should be about the same. If you’ve charged more than you’ve paid, you’ll have to pay the difference to HMRC, but if you’ve paid more than you’ve charged, you’ll get the difference back.
Small businesses and sole traders with an annual turnover of less than £85,000 don’t need to register for VAT. The government can, and does, change the VAT threshold in its annual budget.
How much is VAT?
There are three different rates of VAT. The standard rate in the UK for most goods and services is 20 per cent. Some goods have a reduced rate (currently 5 per cent), such as children’s car seats, domestic fuel and power, and some mobility aids for older people. Some goods have zero VAT, including food, books, newspapers and children’s clothing.
Some goods and services are exempt from VAT, such as financial services, healthcare and property services. Being exempt is not the same as having zero VAT – exempt goods and services are not part of the VAT system, whereas zero rated goods are, it’s just that the government has currently set their VAT rate at zero. This may sound like nonsense, but it’s an important difference: if everything you sell is VAT exempt then you don’t need to register for VAT, whereas if everything you sell is at zero VAT then you still do.
Most exports to countries outside the European Union, or to VAT-registered customers within the European Union, will be at zero VAT. Goods or services that you sell to someone in another EU country who is not VAT-registered will usually be charged as normal.
VAT on invoices
You should add VAT to invoices as a separate amount. So the invoice should show the cost of the goods or services before VAT, the amount of VAT paid and the rate (20 per cent, five per cent or zero), and the total cost with VAT included.
If you are new to VAT, you will have to think about how it will affect your prices, as you will be charging more for the things you sell. Other businesses get their VAT back if they pay too much, so charging them more shouldn’t be a problem. But ordinary consumers can’t do this – so either you or they are going to have to absorb a price hike. You’ll still have to pay the VAT to HMRC, so if you don’t ask your customers for it, it’s coming out of your pocket.
Bear in mind that VAT is designed to be a tax on consumers, not on businesses (that’s why you can claim it back and they can’t), and that it’s meant to be a fair tax – the people who pay more VAT are the people who buy more things because they have more disposable income.
VAT can be complicated, especially if your business is growing rapidly – so don’t be afraid to ask for help from your accountant or financial advisor whenever you need it. He or she should be completely conversant with how the system works and able to help you get to grips with everything you need to know.