VAT can be tricky for small businesses and is often met with a negative view. However, there can be benefits to a small business registering for VAT if done correctly.
When do you HAVE to register for VAT?
A business must register for VAT within 30 days if it’s Sales in any 12 month period goes over the Registration Limit (currently £85,000). That’s any 12 month period on a rolling basis (i.e. the last 12 months from any given point).
However, that’s not necessarily the only reason why a small business would opt to register; it can be done voluntarily (if a business’s turnover is less than the registration limit).
What is VAT?
VAT is a tax on the end user, and if you’re a VAT Registered business, you essentially act as a tax collector for HMRC. You have to add the correct rate (usually 20%) on top of everything you sell. This additional income is not yours – this needs to be paid to HMRC every 3 months when you complete & submit a VAT Return.
However, those nice folk at HMRC also allow you to deduct from this amount any VAT you have suffered (paid).
So, lets assume that in a 3 month period you collect £1,000 in VAT from your customers. In the same period you also buy something from a supplier and you’re charged £200 + VAT (Total: £240).
The amount you have to pay to HMRC is the VAT you’ve collected (often called “Output VAT”) minus the VAT you’ve paid out (“Input VAT”) . So in this example you’ll be handing over £960 (£1,000 minus £40).
You’re essentially £40 better off than you would have been if you weren’t VAT registered.
As well as the possible financial gain, you also stand to boost the credibility of your business. If you’re not registered for VAT, all your customers will know your annual sales are less than the Registration Limit. If you’re registered, there’s no telling. Therefore, you could appear bigger or more established than you are.
Cons of being VAT Registered
There can also be downsides to being VAT Registered. As a VAT Registered business, you’ll be required to calculate and pay VAT to HMRC every quarter by submitting a VAT Return. This could lead to more paperwork and more costs if you pay someone to help you.
If you use an online system like Xero, this shouldn’t be too much bother, as this will handle VAT easily for you.
There’s also the issue if your customers are not businesses and therefore not VAT Registered.
For example, imagine a hairdresser. If they become VAT Registered and have to add 20% on top of their sales price, they suddenly become 20% more expensive and you might consider choosing another barber! Therefore, the most likely scenario is that the hairdresser will need to take on at least some of the cost of the VAT.
There is also the fact they’d now be able to claim back 20% on their costs, for rent, running costs, hair products etc, but this is still sure to either eat into their profits, or scare some customers away.
Flat Rate Scheme
There are also certain scheme’s available for VAT which can in some circumstances earn you a small profit.
The Flat Rate Scheme you are given a flat rate percentage, lower than the current rate of VAT, dependant on the industry you are in. You then pay VAT on your gross sales for the quarter at the flat rate percentage and do not claim back VAT (except on capital purchases over £2k).
For example, if you’re a contractor, only dealing with VAT Registered business, it won’t cause any problems being VAT Registered and charging 20% as your customer will simply claim this back on their VAT.
Therefore, you’ll be charging the customer 20%, but only paying the Flat Rate percentage to HMRC. This could leave you with a profit. However, be aware that you don't fall into the trap of being classed as a Limited Cost Trader.
A business will be classed as a Limited Cost Trader if their purchases of 'goods' are less than either £1,000 or 2% of their sales. If you are caught, you'll need to pay VAT at the Limited Cost Trader rate of 16.5% (which will work out as approximately 20% on all your net invoices). We explain what this is in our blog post here.
So should I Register?
If you sell mainly to non-VAT registered businesses/people, then perhaps not, unless you reach the registration threshold.
If you sell mainly to VAT registered businesses then you probably should, as you'll be making a profit albeit small and also benefit from increased credibility. Just be sure to have the support in place and use software to assist you.
We’d recommend you speak to an accountant before making the decision. If you’d like to speak to a member of our team, feel free to call the office on 023 8061 4457 – we’d be happy to help.
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