Once you have your business up and running, one thing you need to consider is the subject of VAT. At first glance, it might seem complicated and time-consuming , especially for small businesses. However, taken one step at a time, the rules around VAT registration and invoicing are relatively easy to navigate.
After a certain turnover threshold, businesses are obliged by law to register for VAT. But in some cases it can make commercial sense to do it sooner. Here we look at some different scenarios.
Registering for VAT by law
The law states that all traders, whether they be sole traders, limited companies or partnerships, are obliged to charge and pay VAT once their taxable turnover reaches a pre-set annual threshold, which is currently £85,000.
Broadly speaking, a business must register for VAT if:
- Its taxable outputs, including zero-rated sales, have exceeded the registration threshold in the previous 12 months. That’s unless the business can satisfy HMRC that its taxable supplies in the next 12 months won’t exceed £2,000 below the registration threshold (so currently £83,000); or
- There are reasonable grounds to believe that the business’s taxable outputs in the next 30 days will exceed the registration threshold; or
- The business takes over another business as a going concern, to which either of the two points above apply.
Registering for VAT voluntarily
A business can opt to register for VAT voluntarily if its turnover is below the threshold and it may actually save tax by doing so, particularly if its main clients or customers are organisations that can reclaim VAT themselves.
Sandra is a non-VAT registered carpenter and a basic rate taxpayer. She buys a new saw to use in her business, which costs £100 + VAT, so she pays a total of £120 (£100 + VAT at 20%), which can be set against her business profits for income tax purposes. As Sandra is a basic rate taxpayer, she will save tax of £24 (20% of £120), so the saw actually costs her £96.
However if Sandra’s business is VAT-registered, the £20 VAT paid on the item (the input tax) can be reclaimed and £100 is set against business profits for income tax.
The tax reduction is therefore £20 (20% of £100) and the saw actually costs him £80 – saving £16 by being registered for VAT.
Is non-registration preferable?
VAT-registered businesses who supply goods and services to private individuals often feel disadvantaged compared to their non-registered counterparts because they have to charge an additional £20% on every invoice.
A trader who does not want to have to register for VAT may be able to stay below the annual VAT registration threshold by supplying labour-only services and getting customers to buy any goods needed themselves.
David is a non-VAT registered plumber, but his turnover is creeping up towards the VAT registration threshold. He could ask his customers to buy materials for a job directly from a DIY shop. Although the customers will have to pay the VAT on these items, they won’t have to pay VAT on David’s invoice for labour only.
This will also have the advantage of reducing David’s annual turnover for VAT registration purposes.
Benefits of VAT registration
Deciding whether to register for VAT voluntarily before your turnover reaches the VAT registration threshold can have lasting implications for your business due to the increased administration, and so should be given careful consideration.
Where your customers are all VAT registered businesses who can reclaim VAT, generally they will not see a disadvantage of your business being VAT registered. There are several “pros” to support voluntary VAT registration, including:
Although a VAT registered business will have to charge VAT on goods and services (known as charging “output tax”), it will also be able to reclaim VAT that it is charged by other businesses (known as “input tax”).
Where input tax exceeds output tax in a given period, the business will generally be able to reclaim the difference from HMRC. The savings can mount up depending on the level of expenses your business has eg accountancy fees, legal fees and purchases.
Perception in the marketplace
Some businesses choose to register for VAT in order to appear larger than they are. Customers are likely to be aware of the £85,000 registration threshold and so where a business is not registered, its customers will know that the business turnover is lower than this. A business might therefore consider voluntary VAT registration as a way of increasing its standing amongst competitors, and in the eyes of clients.
Help with VAT
If your business is VAT registered, there is an increased administration burden, as you need to make periodic VAT returns – although there is an argument this can be a good thing as it keeps you organised! Most of the accounting packages make this process relatively pain free – and of course your accountant can help.
There are also various,VAT schemes to help small businesses, including the VAT flat rate scheme (FRS). Find out more about it here
Free business guides
If you found this article useful, why not have a look at our jargon-free business guides. These cover a range of topics to help business owners – from VAT registration to claiming expenses, and are completely free to download.
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