Everything you need to know about VAT

Value Added Tax (VAT) impacts how businesses price their products and services, manage their cash flow, and comply with legal obligations.

However, some business owners fail to realise that the VAT reporting requirements for different business structures vary and that there are significant reliefs available to them.

Correctly managing and paying your VAT, mitigating against unnecessary liabilities and planning for future VAT expenses are all part of operating an efficient and effective business.

We have split this article into two so you can find the information pertinent to your specific situation:

1.     VAT for limited companies

2.     VAT for unincorporated businesses (sole traders/partnerships)

Remember, this article is a general overview of VAT and it’s always best to speak to an experienced accountant who can guide you through your VAT liabilities.

VAT for limited companies

A limited company operates as a separate legal entity from its owners, offering distinct advantages and responsibilities under VAT regulations.

These entities must adhere to specific VAT registration criteria, rates, and schemes designed for their business operations.

As a limited company, you must register for VAT if your taxable turnover exceeds the £85,000 threshold set by the Government within any 12-month period.

The registration process involves completing an online application through the HM Revenue and Customs (HMRC) website via the Making Tax Digital for VAT (MTD for VAT) scheme and providing the necessary business details.

Under this scheme, quarterly submitting VAT returns through compatible software and maintaining detailed digital records are necessary requirements.

VAT rates vary, including standard (20 per cent), reduced (5 per cent), and zero rates, depending on the goods or services provided.

·        Standard rate (20 per cent): Applies to most goods and services, including electronics, non-essential items, and standard-rated services such as consultancy.

·        Reduced rate (5 per cent): Charged on some goods and services, including home energy, children's car seats, and sanitary hygiene products.

·        Zero rate (zero per cent): Applies to essential items like food (excluding meals in restaurants or hot takeaways), books (excluding e-books in some cases), newspapers, and children's clothing.

·        Exempt: Certain goods and services are exempt from VAT, such as education and training, insurance, and some types of healthcare and medical treatment.

·        Outside the scope of VAT: These include donations made without receiving anything in return, statutory fees (like the London congestion charge), and goods or services you buy and use outside of the EU.

Limited companies can benefit from specific VAT schemes like the Flat Rate Scheme, simplifying VAT calculations and payments.

The Flat Rate Scheme benefits your business by simplifying the VAT calculation process, allowing you to apply a fixed VAT percentage to your turnover, which can reduce administrative burdens and potentially lower the amount of VAT payable.

Limited companies are required to submit VAT returns, usually quarterly, and make payments to HMRC accordingly. Timeliness is critical, as late submissions or payments can result in penalties.

You can also reclaim VAT on business-related purchases, provided you keep accurate records and receipts to support your claims.

You can effectively get back the full amount of VAT you’ve paid on eligible goods and services, subject to adherence to HMRC guidelines and the provision of valid VAT invoices.

(Limited companies engaged in international trade must navigate additional VAT considerations, particularly when importing or exporting goods and services, requiring careful planning and compliance).

VAT for unincorporated businesses (sole traders/partnerships)

Unincorporated businesses, such as sole traders and partnerships, operate without the legal separation between the business and its owners.

These entities face different VAT obligations and opportunities compared to limited companies.

Like limited companies, unincorporated businesses must register for VAT upon reaching the £85,000 turnover threshold.

The registration process is the same, requiring details about the business to be submitted to HMRC through the MTD for VAT scheme.

Similarly, you’ll need to submit VAT returns each quarter using compatible software and keep detailed digital records.

While subject to the same VAT rates as limited companies, unincorporated businesses may find schemes like the Cash Accounting Scheme more beneficial, allowing VAT payment upon receiving payment from customers, and aiding your cash flow.

In essence, it allows you to pay VAT based on the cash you have actually received, rather than the invoices you’ve issued, so VAT is not paid on sales until the customers have paid your invoices.

Sole traders and partnerships face similar penalties for non-compliance and late payments, so adherence to deadlines is essential.

You can also reclaim VAT on purchases made for business purposes – like limited companies.

However, you must maintain a clear separation between personal and business expenses to ensure accurate reclaiming of VAT – you cannot reclaim VAT on personal items.

Adjustments may be necessary to accurately reflect the business portion of expenses for VAT reclaim purposes.

To sum up, your VAT liabilities are similar to limited companies but:

·        You must distinguish between personal and business assets when reclaiming VAT.

·        You can apply for the Cash Accounting Scheme to assist with cash flow.

·        Your business is linked directly to you, so mistakes and non-compliance are punishable for the individual, rather than the business.

Again, if you require detailed guidance on your VAT obligations it’s always best to speak to a qualified and experienced accountant.

Should you voluntarily register for VAT?

Voluntary VAT registration is when a business chooses to register for VAT before reaching the mandatory £85,000 registration threshold.

You might consider doing this to reclaim VAT on your startup costs and expenses, enhance your business profile by appearing larger and more established, and avoid the sudden requirement to increase prices once you reach the threshold.

By registering early, you can also reclaim VAT on your purchases which can significantly offset your costs.

If you’d like more information on your current or future VAT requirements, or you’d like advice on whether early VAT registration would benefit your business, please get in touch with one of our team.

Please get in touch with the team at Iceberg Accounting for more information or for help managing your VAT payments.