In any industry, VAT is often viewed as a minefield. Of all the various business-related responsibilities, obligations and legislation you have to navigate as a sole trader, few topics cause as much confusion as that dreaded three-letter acronym.
If you’re reading this page, you’re probably a sole trader wondering how VAT works and whether it applies to you. Based on our experience, you’re likely also secretly hoping that it doesn’t actually matter for sole traders, and you can even continue to ignore it.
But VAT, which stands for Value Added Tax, really isn’t something you can ignore. In many ways, VAT impacts sole traders more than larger companies – since you probably don’t have an in-house finance team who can take care of it for you. Instead, as the person responsible for running your business AND reporting tax matters to HMRC, you need to get to grips with what VAT is, how it affects you and what you need to do about it.
Here at Crunch, our accountancy software helps keep sole traders ahead of the game, simplifying your finances and ensuring you don’t fall foul of tax rules. We care about helping sole traders, which is why we’ve created this complete guide to VAT for the self-employed.
Read on to get the knowledge you need, or hop to our VAT submission service to see how we can automate your VAT obligations and make it as easy as possible.
Understanding VAT: An essential guide for the self-employed
So, what is VAT? VAT, or Value Added Tax, is a sales tax charged by VAT-registered traders when selling goods or services. When you charge VAT on things you sell, this is known as ‘output tax’. When you pay VAT, it is ‘input tax’. VAT-registered businesses benefit from being able to reclaim VAT paid on goods and services and also on excess input tax.
That was a fairly simplified explanation, but everything will become more apparent as you read through this guide.
VAT is charged at a ‘standard rate’, ‘reduced rate’ and ‘zero rate’, though some items are also exempt because they are judged as being ‘outside the scope’ of VAT. Businesses that charge VAT must record all their sales and the VAT charged – even if it’s a ‘zero rate’ product/service.
Current rates of VAT (2023/24)
- Standard rate: 20%
- Reduced rate: 5%
- Zero rate: N/A, though the sale must be recorded on your VAT return
To understand how these rates are charged and how you must report them, read our full guide to VAT registration.
Quick overview: When should a sole trader register for VAT?
Some sole traders mistakenly believe that only limited businesses or large corporations must be VAT-registered. The truth is that both limited businesses and sole traders alike are just as liable for VAT registration because it is based on your 12-month turnover, not business structure.
If your business has a total VAT-taxable turnover across any 12-month period that exceeds the VAT threshold, currently set at £85,000, it must register for VAT and apply the appropriate rate of VAT to goods and services you sell.
To make this clear, you should register for VAT if:
- Your 12-month running sales total puts you above the VAT threshold. You must register for VAT as soon as possible. See our VAT threshold article for more information.
- You believe you’ll be eligible for VAT in the near future based on sales forecasts. Remember that VAT is considered across ANY 12-month consecutive period – not just your accounting period.
- You can also voluntarily register if you’re below the threshold, which enables you to reclaim VAT if you pay more VAT than you charge.
The crucial thing to note about VAT is that VAT-registered traders can claim back the VAT they’ve paid on certain eligible goods and services.
This is why some sole traders register voluntarily, especially those who regularly work with larger VAT-registered businesses, as failing to register would mean having to pay the VAT without being able to claim it back.
The VAT Registration Process
If you think you’ll need to register for VAT, most businesses can do so easily via the HMRC website. We’ve covered this process comprehensively in our guide on how to register for VAT, but as a simple overview, you can follow these steps.
1. Gather the information you’ll need to register. As a sole trader, you don’t need an accountant and can do it yourself – you’ll just need the following details:
a. Your date of birth
b. Your National Insurance number
c. ID such as a passport or driving licence
d. Information about your business’s turnover and its nature
e. Your bank account details
f. Any relevant financial records, such as P60s or payslips
2. Sign up, or log-in to this page with your Government Gateway ID.
3. Navigate to the ‘Get another tax, duty or scheme’ page and then select ‘VAT’
4. Follow the steps in the portal and complete your registration.
5. Once completed, you’ll receive a VAT certificate within 30 days that contains your VAT number and details of when your first return is due.
Charging, reporting and paying VAT
If you meet the VAT threshold as a sole trader, you must charge VAT on any applicable products or services you sell. You’re responsible for charging and reporting VAT yourself – which you’ll need to include on your invoices.
How do you determine how much VAT you need to charge? You’ll need to identify which category your product/service falls under and apply the correct rate. For the vast majority of sole traders, this will be the standard rate of 20% – though exceptions apply. Check the government’s VAT rate page for an up-to-date record.
To charge VAT the right way, follow these steps.
- Work out the price you must charge by adding the appropriate VAT rate. For example, if you previously sold a single hour of your services at £50 per hour, and those services fell within the standard rate charge, you’d have to add 20% of £50 to get a final price of £60.
- Include VAT information on each invoice you generate for each sale. Invoices must identify VAT charges as a separate part of the total cost. You’ll also need to include your VAT number somewhere on the invoice.
- Include the transaction in your VAT account.
- Record the amount on each VAT return you complete.
It should be clear from the steps above that for most businesses, the most challenging part of the VAT process involves tracking your VAT costs across multiple invoices – making immaculate bookkeeping vitally important to all VAT-registered businesses.
Submitting VAT returns: When, how, and why
Charging for VAT is only one part of the process. You’ll also need to submit VAT returns, which essentially tell HMRC how much you have charged and how much you have paid, enabling you to reclaim VAT on goods and services bought for the business.
When you first register for VAT, you’ll be given a date for your first VAT return. Unlike your accounts, which are submitted each year, you’ll need to submit more regular VAT returns – usually every three months, but this depends on when you registered and if you have any stagger periods.
Even if you don’t charge or pay VAT in a 3-month period, VAT-registered businesses must still submit a return. You must submit each VAT return no later than one month and seven days after the end of your 3-month VAT period. For most businesses, that means you’ll need to submit four each year.
Why is submitting your VAT return on time so important?
- Failure to submit your return on time will see a penalty point issued by HMRC.
- A £200 fine will be raised when your penalty points exceed HMRC’s set limits, which depend on your accountancy periods. See this page for details.
- Every subsequent late return whilst you remain at the penalty point threshold will incur further charges of £200 – so it’s important to get your points down when you can.
With so much emphasis on self-reporting your VAT and subsequent consequences for late submission, why take the risk of late submission? Use Crunch, and our platform can easily keep you up to date with your VAT obligations. See our easy VAT return guide to learn more.
The Benefits of VAT Registration for the Self-Employed
Considering it means increasing your prices and keeping more detailed records, many sole traders begrudge having to register for VAT. There are, however, plenty of benefits associated with VAT registration.
- VAT-registered businesses can claim for VAT paid out on business-related goods and services.
- Becoming VAT-registered may seem intimidating, but many clients will prefer working with other VAT-registered companies. They can reclaim the VAT they pay on your goods/services, so the actual cost they pay will ultimately be the same as pre-VAT prices.
- A VAT-registered sole trader will charge more, which in turn, means you’ll have more cash flow through your business. This can help make cash flow forecasts more insightful and useful for your business, as long as you are aware of how much you need to set aside to pay your VAT bill at the end of the period.
- Having a VAT number grants more authority to your brand. You can display it on letterheads, email signatures, invoices and more.
Understanding different VAT schemes
HMRC recognises that VAT registration can be complex and carries challenges for sole traders. To help simplify VAT, it offers alternative ‘VAT schemes’ – the most common of which is called the VAT Flat Rate scheme.
This scheme changes the way you pay VAT. Rather than reclaiming the difference between VAT charged and VAT paid, you’ll instead pay a fixed rate of VAT. How much you pay under the flat rate scheme depends on your business, so visit that link to see which rate applies to you.
In some cases, your business may be classed as a ‘limited cost business’ – which happens if your goods cost less than EITHER 2% of your turnover or £1,000 per year. If you’re a limited-cost business, you’ll pay a higher flat rate of 16.5%. Read our guide to VAT flat rates and limited-cost businesses to learn more.
There are other, rarer VAT schemes which only apply to a select few companies. Use the table below, which will help make things clear.
VAT on international sales: rules and guidelines
If you sell goods or services overseas, you’ll need to know about how VAT is handled on international sales.
As a sole trader, determining how international VAT affects you is about working out your places of supply – either where you buy goods from or where your customers are based. If this is an EU country, you don’t need to charge UK VAT but will have to ask for your customer’s VAT registration number, include it on invoices and report it to HMRC during your VAT return.
If you’re a supplier of digital services, you need to know about VAT MOSS. In some cases, VAT-registered sole traders may sell certain digital services to EU customers. If your services fall under VAT MOSS rules, you’ll need to charge and record VAT as outlined in this guide on our site.
If they’re not in the EU, the sale is outside of the scope of VAT, so you won’t need to do anything other than remove any VAT from your invoice/cost.
You’ll need to use the VAT reverse charge if you're buying services from abroad. This is a fairly simple concept that involves the following steps outlined on the Government’s website:
- Convert the full value of any services paid for into sterling.
- Calculate the amount of VAT due on the sale and add it to your VAT return.
- Credit your VAT account with the amount of VAT due, just as you would if you had supplied the service yourself.
- Debit your VAT account with the amount of VAT due.
For more information on international rules around VAT, see our guide to the VAT reverse charge in the construction sector.
Commonly asked questions about VAT for self-employed individuals
VAT is a popular topic of discussion online, with people across the country taking to Google to learn how it may impact them. For sole traders, the following frequently asked questions seem to pop up the most.
“Should VAT be charged on labour?”
Yes. If you’re a sole trader who is either already VAT-registered or will exceed the VAT threshold, you’ll need to charge VAT on your labour time in addition to the cost of goods. Labour is part of your service and therefore, VAT should be calculated and added to it as part of your invoice.
“What can I claim VAT back on self-employed?”
Self-employed people can reclaim the VAT paid on goods or services bought for business use, provided they are VAT-registered. You’ll need to keep records of your payments and invoices when you are reclaiming any VAT.
There are a few exemptions where you can’t reclaim VAT, such as goods or services bought for personal use, entertainment costs for your business, business assets transferred as a going concern, etc.
“Should VAT be included in a quote?”
If you’re a VAT-registered trader and you know you’ll have to charge VAT on the final cost of your goods/service, then you should ideally include VAT as part of any quote. You don’t necessarily have to calculate it – you can quote a price followed by ‘+ VAT’ or ‘ex VAT’ to show that VAT will be charged on top.
Note that you don’t HAVE to include VAT in your quote, but you may end up damaging relationships with customers if you don’t include it and then charge it on the final sale. This sometimes happens in the construction sector, so be mindful if you’re a builder quoting to clients.
Key takeaways of VAT for the self-employed
As we said at the start, VAT can be confusing – which is why we’ve taken the time to create this lengthy guide. Hopefully, however, you’re now better informed about how VAT might impact you and what you can do about it.
It pays to have this knowledge as early as you can in your business journey so you can plan ahead, since sometimes the VAT threshold can seem miles away until you’re suddenly almost reaching it.
To recap, here are the most important points with regard to self-employment and VAT.
- Self-employed people must register for VAT if your sales revenue meets the VAT threshold (£85,000 as of 2023/24).
- As a VAT-registered business, you must charge the appropriate VAT rate against your goods/services – make sure you know which rate applies to you.
- Include VAT on your invoices as a separate charge to make accounting easier for both parties.
- VAT-registered traders can reclaim VAT paid on eligible goods or services.
- Complete a regular VAT return as outlined by the letter you’ll get from HMRC following your registration.
- Consider joining the VAT flat rate scheme or another scheme if it is relevant to your business.
- Keep tight records of VAT paid and charged to make completing VAT returns and reclaiming VAT easier.
Rather than worry about having to manually track VAT, why not try Crunch’s accountancy software? Rather than paying for a dedicated accountant, sole traders can utilise Crunch to take care of many of the laborious tasks associated with bookkeeping – including taking care of your VAT submission. Click here to make reporting, paying and claiming VAT easier for your business.