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VAT registration and reporting explained - and what rate of VAT applies?

VAT registration and reporting explained, image of a man working out tax on a calculator | Crunch

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    Ahh, VAT - most people have heard of it but not many understand it, and we know that it’s confusing for many self-employed, contractors and small business owners.

    Although the ins and outs may be tricky to grasp for first-timers, the sooner you get your head around HMRC’s VAT rules the better it will be for your business.

    First things first – what is VAT?

    VAT – or Value Added Tax – is a tax charged on most goods and services in the UK and the EU. When you buy a product that is eligible for VAT in a shop, for example, VAT is automatically included in the price you pay.

    There are three rates of VAT which are applied to goods and services in the UK. Standard Rate (currently 20%), Reduced Rate (currently 5%) and Zero Rate (0%). Items may also be exempt (or ‘outside the scope’) of VAT. In recent years the UK government has introduced temporary measures to reduce the rate of VAT paid in certain business sectors, such as hospitality. So it’s important to understand the rate of VAT applicable to your business and the purchases it makes.

    “Aren’t Zero Rated VAT and VAT-exempt the same thing?”, you may be asking. Well, no. Zero-rated means that the goods are still VAT-taxable but you don’t charge your customers any VAT. You still have to record these sales in your VAT accounts and report them on your VAT Return, which means you can reclaim VAT on your expenses.

    VAT exempt items are outside of all VAT schemes and are not taxable. You don’t include sales of exempt goods or services in your taxable turnover for VAT purposes. If you buy exempt items, there’s no VAT to reclaim.

    In both cases, you don’t add VAT to the selling price, but zero-rated goods or services are taxable for VAT – albeit at 0%.

    Sales of zero-rated items count as ‘taxable sales’ as far as the VAT registration threshold is concerned, along with sales that are subject to 5% or 20% VAT.

    Temporary reduction in VAT for the hospitality and tourism sector

    In July 2020, as part of the government’s economic measures to respond to the COVID-19 emergency, VAT in the hospitality and tourism sector was reduced from 20% to 5%. The sector includes food outlets, providers of accommodation such as hotels and guest houses, and attractions such as cinemas and theme parks.

    The VAT cut to 5% will remain in place until the end of September 2021. It will then rise to 12.5% for another six months before returning to the full 20% rate in April 2022. No other changes are being made to VAT.

    It will then rise to 12.5% for another six months before returning to the full 20% rate in April 2022. No other changes are being made to VAT.

    Examples of goods and services and their VAT rates

    Here are some examples of goods and services and their VAT rates:

    Standard Rate (20%) Reduced Rate (5%)*1 Zero Rate (0%) Exempt
    Web Design services Energy efficiency materials (insulation etc.) Books* Most financial services
    Electronics (laptops, smartphones etc.) Domestic utilities (gas, electricity etc.) Newspapers*2 Insurance
    Consultancy Nicotine patches Protective clothing (helmets, boots etc.) Lottery tickets
    Photography services Property renovations and alterations Printing of brochures Funeral costs
    Purchasing software or software licenses Sanitary products Buying a helicopter! Houseboat moorings
    Majority of other goods and services Children’s car seats Most construction activities Postage stamps

    *1 As part of the government’s economic measures to respond to the COVID-19 emergency, VAT in the hospitality and tourism sector was reduced from 20% to 5% until September 2021.

    *2 Since 1st December 2020, no VAT is payable on e-books and online newspapers, magazines and journals.

    Who can register for VAT?

    Do sole traders pay VAT?

    There's a common misconception that only limited companies can register for VAT. "Do sole traders pay VAT?" is actually one of the most common questions we hear from prospective sole traders, and the answer is simple: yes, sole traders can register for VAT, too!

    Regardless of your business structure, you can choose to voluntarily register whenever you like, but there comes a point when legally you must register.

    When must I register for VAT?

    Legally, you must register for VAT when:

    • Your VAT-taxable turnover (the total of all sales that aren’t exempt from VAT) exceeds the current threshold of £85,000 within a 12-month period (on a rolling basis)
    • You expect your VAT-taxable turnover to exceed the threshold in a single 30-day period
    • You only sell goods or services that are exempt from VAT, but you purchase goods to use in your business to the value of more than the threshold from VAT-registered suppliers in the EU.

    You need to register for VAT within 30 days of meeting any of these criteria.

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

    There are some situations in which it may be beneficial to voluntarily register for VAT before you reach the threshold, we cover voluntary VAT registration later in this article.

    If you are using the VAT MOSS scheme you may need to register for VAT in the UK - read our article for more detail on VAT MOSS.

    When should I start charging VAT?

    When your turnover reaches the VAT threshold in a rolling 12 month period, you must start charging VAT from the first day of the second month after you exceed the threshold.

    For example, if on 30th June 2021, your sales for the previous 12 months are £85,000, then your VAT registration date will be 1 August 2021.

    When you expect to exceed the threshold in a single 30-day period, you must start charging VAT immediately.

    Why is VAT charged on top of recharged expenses?

    Recharges are costs that your business incurs when supplying goods and services which you pass on to your customers. If you’re VAT registered, you’ll need to charge VAT on the amount recharged to the client, even if the expenses your business initially incurred and paid for are not subject to VAT.

    A good example is a train ticket, which is not subject to VAT rules. If you pay £100 for your ticket, you include that amount as an expense in your company accounts. However, if you pass the cost on to your client and include it on a sales invoice, you need to add VAT. This situation is quite different to your client reimbursing expenses at cost.

    There’s no requirement for you to charge the client the same amount you paid in expenses. So using the above example, if you decided to charge your client £150, you would need to add VAT to that amount.

    Business Expenses made simple with our guide.

    What happens if I don’t register for VAT when I should?

    If you’re late in registering, HMRC will retrospectively register your business from the date you should have started charging VAT. You’ll need to add VAT to all sales made from this retrospective date, regardless of whether you actually charge your clients VAT, so you could well lose out if you don’t register when you should. HMRC may also issue you with a financial penalty.

    If you know your turnover will reach the threshold soon, you should allow enough time to register. If you fail to notify HMRC in time, you may be liable to pay a penalty!There are some situations in which it may be beneficial to register voluntarily before you reach the threshold.

    Why would I consider voluntary VAT registration?

    There are a number of reasons why it might be worth voluntarily registering for VAT even if your turnover is not above the VAT threshold. These include:

    • You can reclaim the VAT on your business expenses (if you are on the Standard Rate scheme)
    • You can register for a reduced Flat Rate of VAT to reduce the administration involved in preparing your quarterly VAT return (Flat Rate scheme)
    • If your clients are large companies who are themselves VAT registered, registering could be advantageous. Your clients will be used to seeing prices inclusive of VAT, and will be able to reclaim the VAT paid over to your business
    • It may make your business more credible in the eyes of your clients, in the same way that having a limited company makes you appear more 'professional’.

    You should speak to an accountant for individual advice on your situation.

    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 usually requires you to add 20% to your invoices, and if your client isn’t VAT registered, they can’t reclaim this
    • With VAT registration comes additional responsibility. You’re required to complete and file a VAT return, usually every three months. If a return is late, there will be a penalty from HMRC
    • Since 1st April 2019, if you're above the VAT threshold, you need to comply with Making Tax Digital for Business rules, which means keeping electronic records and submitting digitally using approved software such as Crunch.
    • When you’re VAT registered, it can be more difficult to keep track of your cash flow and profit. However, as a Crunch client, we’ll calculate your VAT liabilities automatically, so you’ll always have an up-to-date picture of your accounts.

    How do I register for VAT

    Registering for VAT is usually done online - Gov.uk has all the information you need for how to do it, or if you use online accounting software like Crunch, then we'll take care of all the registration for you as well as all your filing and calculations. Firstly you need to decide whether you should register for Standard Rate VAT or Flat Rate VAT.

    Standard Rate VAT vs Flat Rate VAT schemes

    When you register for VAT, you have two choices of schemes. The first, Standard Rate VAT, involves reclaiming VAT on every eligible item you buy or sell. The second, Flat Rate VAT, is open to businesses with an expected turnover of less than £150,000 (in the next 12 months) and was introduced to simplify the VAT system for freelancers, contractors, and small businesses.

    On the Flat Rate VAT scheme, you’ll use a predetermined VAT rate based on your industry type and pay this over to HMRC. First, you add the Standard VAT rate of 20% to your sales invoice amount, then you collect the full amount from your client. Next, apply your sector percentage to this (gross) amount, which is then paid over to HMRC via a VAT return. The difference between the two rates is retained by your business (limited company) as income.

    There’s a range of VAT rates for specific industry types available below. We’ve also got an article explaining the Limited Cost Trader Test that is used by many “labour-only businesses” such as contractors.

    When you register for the Flat Rate scheme for the first time, HMRC allows you to apply a 1% discount in the first year.

    Computer and IT consultancy or data processing
    Type of business 2021/2022 & 2020/21 Flat rate (%)
    Accountancy or bookkeeping 14.5
    Advertising 11
    Agricultural services 11
    Any other activity not listed elsewhere 12
    Architect, civil and structural engineer or surveyor 14.5
    Boarding or care of animals 12
    Business services not listed elsewhere 12
    Catering services including restaurants and takeaways before 15th July 2020 12.5
    Catering services including restaurants and takeaways from 15th July 2020 to 30th September 2021 4.5
    Catering services including restaurants and takeaways from 1st October 2021 to 31st March 2022 8.5
    14.5
    Computer repair services 10.5
    Entertainment or journalism 12.5
    Estate agency or property management services 12
    Farming or agriculture not listed elsewhere 6.5
    Film, radio, television or video production 13
    Financial services 13.5
    Forestry or fishing 10.5
    General building or construction services* 9.5
    Hairdressing or other beauty treatment services 13
    Hiring or renting goods 9.5
    Hotel or accommodation before 15th July 2020 10.5
    Hotel or accommodation from 15th July 2020 to 30th September 2021 0
    Hotel or accommodation from 1st October 2021 to 31st March 2022 5.5
    Investigation or security 12
    Labour-only building or construction services* 14.5
    Laundry or dry-cleaning services 12
    Lawyers or legal services 14.5
    Library, archive, museum or other cultural activity 9.5
    Limited cost trader 16.5
    Management consultancy 14
    Manufacturing fabricated metal products 10.5
    Manufacturing food 9
    Manufacturing not listed elsewhere 9.5
    Manufacturing yarn, textiles or clothing 9
    Membership organisation 8
    Mining or quarrying 10
    Packaging 9
    Photography 11
    Post offices 5
    Printing 8.5
    Publishing 11
    Pubs before 15th July 2020 6.5
    Pubs from 15th July 2020 to 30th September 2021 1
    Pubs from 1st October 2021 to 31st March 2022 4
    Real estate activity not listed elsewhere 14
    Repairing personal or household goods 10
    Repairing vehicles 8.5
    Retailing food, confectionery, tobacco, newspapers or children’s clothing 4
    Retailing pharmaceuticals, medical goods, cosmetics or toiletries 8
    Retailing not listed elsewhere 7.5
    Retailing vehicles or fuel 6.5
    Secretarial services 13
    Social work 11
    Sport or recreation 8.5
    Transport or storage, including couriers, freight, removals, and taxis 10
    Travel agency 10.5
    Veterinary medicine 11
    Wholesaling agricultural products 8
    Wholesaling food 7.5
    Wholesaling not listed elsewhere 8.5

    *‘Labour-only building or construction services’ means building services where the value of the materials supplied is less than 10% of the turnover for those services. If more than this amount, the business is classed as ‘General building or construction services’.

    How do I know which VAT scheme is best for me?

    Generally, when deciding whether to register and on what scheme, you need to look at your turnover, the type of clients you have, and the expenses you incur that you can claim VAT on.

    The table below is a guide to which scheme may be more appropriate for you. It’s important to remember that this should only be used as a guide, nothing beats getting direct support from one of our expert accountants to discover what’s best for you and your business.

    Turnover VAT - taxable expenses Client type Suggested VAT option
    Less than £85,000 Less than 1.5% of turnover Mostly non-VAT registered customers Don’t register for VAT
    Any More than 1.5% of turnover Mostly VAT registered customers Register for standard rate VAT
    More than £85,000 Less than 1.5% of turnover Any Register for Flat Rate VAT

    Example using the 14.5% Flat Rate

    Your business charges £1,000 to a client for services your company provides. The client will pay £1,200 including the Standard Rate of VAT amount at 20% (£200). Your business pays HMRC the industry Flat Rate of VAT amount at 14.5% of £1,200 which is £174. The business accounts for the difference (£26) as income.You can’t reclaim the VAT paid on your purchases under the Flat Rate scheme - except for certain capital assets over £2,000.

    When you register for the Flat Rate scheme for the first time, HMRC allows you to apply a 1% discount in the first year.

    How often do I need to file a VAT return?

    You’ll need to file a VAT return every three months. If you do not file a return when it is due, you’ll incur a penalty from HMRC.If you’re a Crunch client, our software automatically generates your VAT return. You’ll be notified when a return is ready. Simply let us know you’re happy with it and we’ll file on your behalf.

    If you’re not a Crunch client then you’ll need to use HMRC approved software to file your VAT return since the government's MTD for VAT scheme came into force on 1st April 2019.

    How do I report VAT and file a VAT return?

    For a registered business, a VAT 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 income and expenses, you may need to make a VAT payment to HMRC or you may be owed a refund.

    Since 1st April 2019, all VAT-registered businesses have had to submit their VAT returns digitally, under the government's new “Making Tax Digital” initiative. You can find out more information on MTD on our Making Tax Digital hub.

    What is VAT MOSS?

    VAT MOSS (short for Value Added Tax: Mini One Stop Shop) is a way of paying VAT for businesses supplying digital services directly to customers in EU countries.VAT MOSS covers businesses supplying digital services to customers (known as ‘B2C’). The services include broadcasting, telecoms and e-services. The rules apply to sole traders and limited companies.If you supply digital services to businesses (known as ‘B2B’) then VAT MOSS doesn’t apply.

    Read our article for more information on VAT MOSS.

    Paying any VAT to HMRC if you deferred a payment between 20th March and 30th June 2020 - Pay now or join the VAT deferral scheme

    If you deferred VAT payments due between 20th March and 30th June 2020 and still have payments to make, you have the choice to:

    You may be charged a 5% penalty or interest if you do not pay in full or make an arrangement to pay by 30th June 2021. The original deadline for paying in full was 31st March 2021, but HMRC has said that you may be able to avoid being charged penalties or interest, provided you join the VAT deferral new payment scheme before 21st June 2021, or pay in full by 30th June 2021.The VAT deferral new payment scheme let's you pay your outstanding VAT in installments.

    If you join the scheme, you can still have a 'Time to Pay' arrangement for other HMRC debts and outstanding tax.

    Full details are on Gov.uk.

    What should I do next?

    If you’re close to the VAT threshold (or think you may be), then your accountant should be able to advise you on whether you should consider registering and what scheme would be best for you.

    If you don’t yet have an accountant or are thinking of switching, then why not speak to Crunch - our combination of online accounting software and unlimited access to a dedicated client manager and expert accountants could be just right for you. Find out more about how we can help you and your business.

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