We highlight the key VAT areas you need to consider when running your business.
VAT registered businesses act as unpaid tax collectors and are required to account both promptly and accurately for all the tax revenue collected by them.
Scope
A transaction is within the scope of VAT if:
- there is a supply of goods or services
- it was made in the UK
- it was made by a taxable person
- it was made in the course or furtherance of business.
Inputs and outputs
Businesses charge VAT on their sales. This is known as output VAT and the sales are referred to as outputs. Similarly, VAT is charged on most goods and services purchased by the business. This is known as input VAT.
The output VAT is being collected from the customer by the business on behalf of HMRC and must be regularly paid over to them.
However, the input VAT suffered on the goods and services purchased can be deducted from the amount of output tax owed. Please note that certain categories of input tax can never be reclaimed, such as that in respect of third party UK business entertainment and for most business cars.
Supplies
Taxable supplies are mainly either standard rated (20%) or zero rated (0%). There is, also, a reduced rate of 5%, which applies to a small number of certain specific taxable supplies.
Certain supplies are not taxable and these are known as exempt supplies.
There is an important distinction between exempt and zero-rated supplies.
- If your business is making only exempt supplies, you cannot register for VAT and therefore cannot recover any input tax.
- If your business is making zero rated supplies, you should register for VAT as your supplies are taxable (but at 0%) and recovery of input tax is allowed.
It is imperative that you correctly determine whether your supplies are taxable and the correct rate to apply.
Registration
You are required to register for VAT if the value of your taxable supplies exceeds a set annual figure (currently frozen at £85,000).
If you are making taxable supplies below the limit, you can apply for voluntary registration. This would allow you to reclaim input VAT, which could result in a repayment of VAT if your business was principally making zero rated supplies.
If you have not yet started to make taxable supplies but intend to do so, you can apply for registration. In this way, input tax on start-up expenses can be recovered.
Taxable person
A taxable person is anyone who makes or intends to make taxable supplies and is required to be registered. For VAT registration, a person includes:
- individuals
- partnerships
- companies, clubs and associations
- charities.
Suppose any individual carries two or more businesses. In that case, all the supplies made in those businesses will be added together in determining whether or not the individual is required to register for VAT.
Administration
Once registered you must make a quarterly return to HMRC showing amounts of output tax to be accounted for and of deductible input tax together with other statistical information. All businesses have to file their returns online. If your annual turnover exceeds the registration limit of £85,000, the VAT return must be filed digitally under Making Tax Digital.
Quarterly VAT returns must be completed within one month and seven days of the quarter-end. For annual returns, the deadline is two months after the VAT period end. Electronic payment is also compulsory for all businesses.
Businesses who make zero rated supplies and who receive repayments of VAT may find it beneficial to submit monthly returns.
Businesses with expected annual taxable supplies not exceeding £1,350,000 may apply to join the annual accounting scheme whereby they will make monthly or quarterly payments of VAT but will only have to complete one VAT return at the end of the year.
The cash accounting scheme can also be very beneficial for those with clients who do not pay immediately. This scheme allows you to only pay over output VAT when the client has paid, but it does also mean you cannot claim for input VAT on your purchases until you have paid your supplier.
The flat rate scheme allows smaller businesses to pay VAT as a percentage of their total business income. Therefore, no specific claims to recover input tax need to be made. The scheme aims to simplify the way small businesses account for VAT, but for some businesses, it can also result in a reduction in the amount of VAT that is payable.
Record keeping
It is important that a VAT registered business maintains complete and up to date records. This includes details of all supplies, purchases and expenses.
In addition, a VAT account should be maintained. This is a summary of output tax payable and input tax recoverable by the business. If you are using accounting software to complete your VAT returns, the software does it for you. These records should be kept for six years.
Inspection of records
The maintenance of records and calculation of the liability is the responsibility of the registered person, but HMRC will need to be able to check that the correct amount of VAT is being paid over. From time to time, a VAT officer may come and inspect the business records. This is known as a control visit.
The VAT officer will want to ensure that VAT is applied correctly and that the returns and other VAT records are properly written up.
However, you should not assume that in the absence of any errors being discovered, your business has been given a clean bill of health.
Offences and penalties
HMRC have wide powers to penalise businesses who ignore or incorrectly apply the VAT regulations. Penalties can be levied in respect of the following:
- late returns/payments
- late registration
- errors in returns.
Making Tax Digital for Business: VAT
Under Making Tax Digital for VAT (MTDfV), businesses with a turnover above the VAT threshold must keep digital records for VAT purposes and provide their VAT return information to HMRC using MTD functional compatible software.
The rules have effect from 1 April 2019, where a taxpayer has a ‘prescribed accounting period’ which begins on that date, and otherwise from the first day of a taxpayer’s first prescribed accounting period beginning after 1 April 2019.
Keeping digital records and making quarterly updates will not be mandatory for taxes other than VAT before April 2023. However, businesses below the VAT threshold which have voluntarily registered for VAT can opt to join the scheme.
Last updated: 17.11.2020
Whilst the information in this document is correct; you should always obtain individual advice from a qualified accountant.