Ahh VAT – another one of those labyrinthine HMRC schemes that seems more designed to baffle and enrage than to help business owners.

Although the ins and outs may be tricky to grasp for first-timers, the sooner you get your head around the HMRC VAT system the sooner you can benefit from it.

First things first – what is VAT?

VAT – or Value Added Tax – is a tax charged on most goods and services in the UK and some in the EU. When you buy a product that is eligible for VAT in a shop, for example, it will be automatically added on top.

There are three rates of VAT which are applied to goods and services. Standard Rate (currently 20%), Reduced Rate (currently 5%) and Zero Rated (0%, obviously). Items may also be exempt (or ‘outside the scope’) of VAT.

“Aren’t 0% VAT and VAT exempt the same thing?”, you may be asking. Well, no – a 0% VAT rate means you can still reclaim costs in your HMRC VAT return, whereas with a VAT-exempt item you cannot.

Some examples of goods and services and their VAT rates:

Standard Rate Reduced Rate Zero Rated Exempt
Web Design services Energy efficiency materials (insulation etc.) Books Most financial services
Electronics (laptops, smartphones etc.) Domestic utilities (gas, electricity etc.) Newspapers Insurance
Consultancy Nicotine patches Protective clothing (helmets, boots etc.) Lottery tickets
Photography services Property renovations and alterations Printing of brochures Funeral costs
Purchasing software of software licenses Sanitary products Buying a helicopter! Houseboat moorings
Majority of other goods and services Children’s car seats Most construction activities Postage stamps

More information on VAT for businesses can be found here.

Standard Rate vs Flat Rate schemes

If and when you register for VAT you have two choices of schemes. The first, Standard Rate, involves manually reclaiming VAT on every eligible item you buy or sell. The second, Flat Rate, is open to businesses with a turnover less than £150,000 and was introduced to simplify the VAT process for freelancers, contractors and small businesses.

On the Flat Rate scheme you will simply apply an HMRC-mandated rate to your turnover based on your sector. Common Flat Rate rates for one-person businesses include –

Sector Rate
IT Consultancy 14.5%
Photography 11%
Journalism 12.5%
Accountancy 14.5%
Computer Repair 12.5%
Other B2B services 12%
Any other service 12%

To make the Flat Rate scheme even more appealing, HMRC allow new registrants to apply a 1% discount to their rate for their first year of registration.

You can see a full list of sectors and their associated rates here.

Who can register for VAT?

There is a common misconception that only people operating their own limited company can register for VAT, when actually VAT registration is open to anyone; sole trader or limited. You can voluntarily register whenever you like, however there comes a point when legally you must register.

When should I register for VAT?

Registration is mandatory if your turnover for the past year has exceeded the VAT registration  threshold (see the current threshold here). It’s important to note this is calculated on a rolling basis, so we’re talking about your turnover in the twelve months directly preceding the current month, not in the last financial year.

If you know your turnover will reach the threshold soon, you should allow enough time to register beforehand. If you fail to notify HMRC in time, you may be liable for a penalty!

There are some situations in which it may be beneficial to register voluntarily before you hit the threshold.

Why would I consider voluntary VAT registration?

  • You can reclaim the VAT on your expenses (Standard Rate scheme only)
  • There are potential savings to be made by being VAT registered (Flat Rate scheme only)
  • If your clients are large companies who are themselves VAT registered, registering could be advantageous. They will be used to seeing prices inclusive of VAT, and will be able to reclaim the VAT.
    • It may make you more credible in the eyes of your clients, in the same way that having a limited company makes you appear more ‘professional’.

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Why might I not want to register voluntarily?

  • If your clients are smaller companies and not VAT registered themselves, the addition of VAT may make you seem more expensive. Registering for VAT requires you add 20% to your invoices, and if your client isn’t VAT Registered, they cannot reclaim this
  • With VAT registration comes additional responsibility. You are required to complete and file a VAT return, usually every three months. If a return is late, there will be a penalty from HMRC
  • When you are VAT registered there is a potentially increased difficulty in keeping track of your cashflow and profit

How do I report VAT?

For VAT Registered business, a tax return is required (usually every quarter) to tell HMRC how much VAT you have paid and received. All VAT Returns are filed online, and can usually be handled by your accounting software. Depending on your expenditure you may have to make a VAT payment to HMRC, or be owed a VAT refund.