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Understanding VAT and Its Threshold
Value Added Tax (VAT) is a form of taxation charged by VAT-registered businesses on most goods and services in the United Kingdom, as well as on specific services imported from other European Union nations. Since 2017, the VAT registration threshold in the UK has remained steady at £85,000, and this figure is projected to remain unchanged until 31 March 2024.
When Should a Business Register for VAT?
The necessity for a business to register for VAT hinges largely on its taxable turnover. If your business’s taxable turnover exceeds £85,000 within a 12-month period, it is required to become a VAT-registered entity. This means that you will add VAT to the sales prices for your customers, collect the amount, and then remit it to HM Revenue & Customs, subtracting any VAT you have incurred on your purchases.
Businesses may also voluntarily become VAT-registered. This often holds a few distinct advantages. For example, a VAT-registered business can usually reclaim the VAT it has incurred when purchasing goods or services.
Knowing the Right Time to Register for VAT
Understanding when to register your business for VAT is critical. Several factors come into play, from the amount of your taxable turnover to changes in the law, such as the recent ‘Making Tax Digital’ laws which require businesses to use reliable accounting software for VAT returns. Let’s break down some important points to consider.
Compulsory VAT Registration Threshold
The threshold for mandatory VAT registration in 2023 is set at £85,000, and it will remain so until 31 March 2024. If your business’s taxable turnover surpasses this threshold over any consecutive 12-month period, VAT registration becomes mandatory.
Certain other scenarios can also necessitate VAT registration. For example, if you acquire a VAT-registered business and the combined taxable turnover of your business and the acquired business over the last 12 months exceeds the VAT registration threshold, your business must register for VAT. Additionally, if your business anticipates that its turnover will surpass the threshold within the next 30 days, you must register for VAT.
Failing to register on time can result in late registration penalties or ‘failure to notify’ penalties. Furthermore, your business may incur surcharges and interest for late payment if it has a VAT liability. If your business’s turnover temporarily exceeds the VAT threshold, you can request an exemption from registration with HMRC.
Voluntary VAT Registration
Even if your business’s taxable turnover does not surpass the current VAT registration threshold, you can still opt to voluntarily register for VAT. This may provide certain benefits, such as the ability to recover VAT when your customers are predominantly other VAT-registered businesses or when your business often finds itself in a refund position with HMRC.
Who Can and Cannot Register for VAT?
An entity is ineligible for VAT registration if it fails to satisfy HMRC’s definition of a business for VAT purposes. In addition, a business that primarily sells goods or services exempt from VAT is also precluded from registering.
Contemplating Customer Profile
Whether or not to register for VAT requires careful consideration of the customer base. Let’s examine this using a retailer as an example.
In instances where a retailer’s customers are mostly other VAT-registered businesses, they will not object to VAT charges because they can reclaim it from HMRC. In such cases, the business may benefit from VAT registration as it allows for the recovery of VAT on its own purchases. It’s worth noting that this isn’t a dubious tactic; it’s estimated that approximately 20% of all VAT-registered businesses operate below the VAT registration threshold.
However, if a retailer primarily serves the general public, who are not VAT-registered, these customers cannot recover the VAT. Therefore, VAT becomes an extra cost for the public and can potentially inflate retail prices. If a retailer’s competitors aren’t VAT-registered, their prices might not be as competitive.
Understanding Different VAT Rates
To illustrate further, let’s break down the various categories of items for VAT purposes:
| Name | Current Rate | Description and Examples |
|---|---|---|
| Standard | 20% | The default rate applicable to most goods and services in the UK, unless explicitly identified as reduced or zero-rated. |
| Reduced | 5% | Applies to specific items such as domestic fuel and power, sanitary hygiene products, and children’s car seats, among others. |
| Zero | 0% | Items such as food (excluding restaurant meals and hot takeaways), books, children’s clothes, and public transport, etc. |
| Exempt | N/A | Legally stipulated goods or services on which VAT cannot be charged. Examples include insurance, education, fundraising, and membership, etc. |
| Outside the scope | N/A | Items completely outside the UK VAT system, such as drawings, wages, MOT tests, rates, etc. |
Certain industries, like farming, often find themselves in a VAT refund position. Their direct purchases and sales are mostly zero-rated, but they can reclaim any VAT incurred on overheads or equipment. Other examples of businesses that might voluntarily register for VAT include greengrocers or children’s shoe shops.
Selecting an Appropriate VAT Scheme
Once you’ve established when to register for VAT, the next step is to identify the most suitable VAT scheme for your business. Here are three primary options:
VAT Flat Rate Scheme
This scheme is available for businesses with a taxable turnover of less than £150,000. It simplifies record-keeping for small businesses by applying a fixed-rate percentage to turnover, depending on the industry. For more detailed information, you can refer to the HMRC’s guide.
VAT Cash Accounting Scheme
The VAT Cash Accounting Scheme is another popular option, especially for start-ups and small businesses with a turnover of less than £1.35 million. Under this scheme, VAT on your sales is only due once your customers have paid their invoices. Similarly, you only reclaim VAT on your purchases once you have paid your suppliers.
Usually, VAT is payable to HMRC irrespective of whether you have received payment from your customers, which can potentially create cashflow issues. However, note that the VAT Flat Rate Scheme cannot be combined with the VAT Cash Accounting Scheme.
Annual Accounting Scheme
The Annual Accounting Scheme enables businesses to submit one annual return, as opposed to quarterly returns. This scheme allows for advance payments using estimated amounts based on the previous year’s return.
After completing your return, a final payment can be made to cover any deficit between your advance payments and the final bill, or a VAT refund can be requested if you’ve overpaid.
What are the Penalties for Non-Compliance?
Businesses are obliged to register for VAT within a specific timeframe if their turnover exceeds the threshold. Failure to register punctually may result in late registration penalties and/or ‘failure to notify’ penalties. Additionally, surcharges and interest are likely to be imposed for late payment if the business has a VAT liability.
If your business’ turnover exceeds the VAT threshold temporarily, you can request an exception from registration with HMRC.
Concluding Remarks
Understanding VAT registration and its complexities is essential for all businesses operating within the UK. Whether you’re considering compulsory or voluntary VAT registration, careful deliberation is required to ensure you make the most beneficial decision for your business.
Remember, while the VAT registration threshold remains at £85,000 until March 31, 2024, businesses must keep track of their taxable turnover over any consecutive 12-month period. If this exceeds the threshold, VAT registration becomes obligatory.
With diverse VAT rates and schemes available, businesses should take time to comprehend these aspects thoroughly. It’s recommended to seek advice from a financial advisor or directly from the HMRC to ensure your business meets all its VAT responsibilities.
Finally, bear in mind that accurate and reliable accounting software is invaluable for managing VAT returns effectively, especially since the introduction of the ‘Making Tax Digital’ laws.
In our subsequent guide, we will walk you through the process of VAT registration. Stay tuned for more detailed insights into navigating VAT management in the UK.
