Value Added Tax (VAT) is a charge applied to the majority of business transactions involving the transfer of goods and/or services. VAT is applied to (almost) everything that you buy or sell, from raw materials to finished products and services.
Whether limited or not, every business must register for VAT once their turnover exceeds the threshold set by HMRC. Note that this threshold applies to the total turnover, not the profit. In the UK, the current VAT threshold is £85,000 of turnover within any 12-month period. Once the turnover threshold has been met, you are legally required to register your company for VAT within a 30-day period. You do so by completing the VAT1 form , which can be done online.
Standard, reduced and zero-rate VAT
The standard VAT rate of 20% applies to the majority of goods and services, though some benefit from a reduced rate or are exempt entirely. Such items include books, children’s clothes and motorcycle safety gear. Note that even if you only deal in goods and/or services classed as zero-rated for VAT purposes, you still need to register for VAT when you hit the transaction threshold – as well as record and report their sale and purchase. If in doubt, check the full list of VAT rates on different goods and services .
How VAT works in practice
Once you're registered for VAT, your business will pay Value Added Tax on any purchases it makes. This is called input tax. Your business will also charge VAT on all your sales, which is called output tax. As you file your VAT Return – typically every three months – you will include both figures for assessment. If your business receives more money in output tax than it pays as input tax, the difference must be paid to HMRC. If, on the other hand, your business input tax ends up greater than the output tax paid, you will be able to reclaim the difference.
Keeping VAT Records
Registering for VAT implies some changes to the running of your business and the records you keep. Your ordinary business records should be easy enough to adapt in order to provide the necessary information. Note that you'll need to retain your VAT records for a minimum of six years.
How VAT works for sales
All supplies to VAT-registered customers, regardless of rate, will need to be invoiced for VAT. VAT invoices must show:
- The amount charged
- The VAT rate charged
- Your business' VAT number.
In addition, you will need to retain copies of all VAT invoices issued by your business, and to maintain a separate record detailing all the VAT that your business has charged.
How VAT works for purchases
In order to apply for VAT refunds, you will need a VAT invoice for each purchase. This must show:
- The amount charged
- The rate charged
- The supplier's VAT number
Retain copies of all the VAT invoices you receive, and keep a separate record detailing the amount of input tax you have paid.
Voluntary VAT registration
It is possible to register for VAT voluntarily, i.e. even if your current turnover is below the current threshold. There are various reasons you might want to do this.
First and foremost, charging VAT on the goods and services you provide also allows you to claim input tax refunds on VAT-applicable transactions you make with other companies. This can amount to a significant sum.
From the point of view of your VAT-registered customers, registering your company allows them to reclaim VAT they pay on transactions with you. This makes transactions with your firm more favourable to customers and suppliers than transactions with non-VAT-registered competitors.
Finally, some people may prefer to do business with VAT-registered companies because they see it as a marker of larger, more established businesses. This could be a way to boost your credibility with potential customers.
One downside of registering for VAT is that it will increase your rates for any non-VAT registered customers. You will also incur additional paperwork.