WHAT IS VAT
VAT stands for “Value Added Tax”. It is a sum added onto the cost of supplying goods and services by a business. There are different rates of VAT. At present these are
- Standard – 20%
- Lower – 5%
- Zero – 0%
Some supplies are exempt from VAT. Although the VAT charge is the same as for zero rated supplies (i.e. nil) they must be identified separately in the financial records of the business.
A VAT registered business must add VAT (technically “Output VAT”) at the correct rate to its sales. It can reclaim VAT (technically “Input VAT”) on its purchases. The net balance is paid to HMRC. If the input VAT is greater than the output, the balance is reclaimed from HMRC. This can happen when a large portion of sales are zero rated or the business has large one-off costs such as capital purchases or if it is stocking-up.
If your business is turning over more than £85,000 in VAT taxable income per year, you must be registered with VAT. For VAT purposes the “year” is any 12-month period, not the normal accounting year for the business. The business must register for VAT within 30 days after the end of the month in which it met the £85,000 threshold.
You can register voluntarily if your turnover is less than £85,000, unless all of your products are VAT exempt.
VAT RECORDS AND RETURNS
HMRC requires businesses to maintain comprehensive VAT records. The requirements have become more complex since the introduction of Making Tax Digital (MTD) for VAT. It is well worth setting up your processes before your business takes off. A bit of time spent planning can save a lot of time later when records have been lost or processed incorrectly.
Businesses must retain records of all sales and purchases, including the VAT on each. It must also keep a summary VAT account; this is used to prepare the VAT returns and provide supporting evidence if HMRC needs it.
Records must be kept for at least 6 years (or longer in some circumstances).
Returns must be submitted electronically; paper returns are no longer allowed. Returns are normally submitted quarterly but businesses can elect for monthly or annual returns. Occasionally HMRC will demand monthly returns.
CORRECTION OF ERRORS
HMRC allows businesses to correct errors in VAT returns that have been submitted. They must be corrected as soon as possible after the error is discovered. If the amount of the VAT error is either:
- Less that £10,000
- Between £10,000 and £50,000 and less than 1% of the net VAT on the next return
and the error was not deliberate, or happened despite taking reasonable care, the business can simply adjust the figures on the next return.
Otherwise the error must be reported to HMRC on a separate form, VAT 652.
MAKING TAX DIGITAL
At present MTD is not mandatory for businesses with a VATable turnover of less than £85,000. Other businesses must comply with the requirements for data processing, record keeping and VAT returns. MTD returns must be submitted electronically; HMRC automatically rejects returns that do not comply with the rules in every respect.
MTD means that businesses must record VAT transactions electronically and link each stage of the processing from the point of data capture to the VAT return itself. Data cannot be kept exclusively on paper or as images or PDFs; it must be digitised. Data cannot be transferred between systems or into the VAT return by rekeying or using “cut and paste”.
Effectively this means businesses must use a MTD compliant system. Traditional paper-based ledgers are not allowed. Spreadsheets are permitted provided they meet strict criteria but these can consume a lot of time.
HMRC have various schemes to help taxpayers.
- Flat rate – Simplified VAT accounting for small businesses
- Retail schemes – Pay the correct amount of VAT without recording VAT on each sale. This is especially helpful for small retailers who cannot justify the cost of complex point-of-sale systems
- Second-hand goods – VAT is calculated on the reseller’s margin instead of the full selling price
- Annual accounting – cut down administration by submitting one VAT return per year instead of four
- Monthly returns – a business that regularly receives VAT rebates can elected to submit returns, and receive the rebate, monthly
- Cash accounting – businesses with a VAT’able turnover of less than £1.35 million can use “Cash” accounting. This means VAT is accounted for when payments are received or made, rather than the date of the transaction itself.
DOING BUSINESS ABROAD
There are special rules for making or receiving supplies outside the UK. For example, you may need to apply a process known as “reverse billing” on some services provided by non-UK businesses. In the modern Ecommerce world, this is more likely that you would expect. Google Adwords is just one situation where it applies.
As well as UK requirements, you may need to comply with VAT rules in other countries. Although the basic process is broadly similar across all EU states, there are some significant differences in the details.
If you are considering buying or selling across borders, you should seek professional guidance. The consequences of making mistakes are serious.
RECLAIMING VAT ON PRE-REGISTRATION COSTS
You are allowed to reclaim the VAT you paid on certain purchases made before you register for VAT, although there is a time limit on how far you can backdate claims. These are
- 4 years for goods you still have, or raw materials used to make goods you still have
- 6 months for services, provided the services relate to VAT’able sales after registration the registration date. This is not simple to assess as the business benefit of some services does not fall in a specific period. For example, advertising expenditure can generate new leads and sales for a considerable period after the publication date.
You can reclaim these costs on your first VAT return, but your records must contain evidence that VAT was paid such as:
- Invoices and receipts
- Description and purchase dates
- Justifications for their relevance to your business
It is also possible to request the VAT registration date to be backdated by up to 4 years. This can be worthwhile for businesses making supplies that are mainly zero-rated.
An accountant can help you ensure that you are doing VAT in the most tax-efficient and HMRC compliant manner, to ensure that you are saving money and avoiding fines. To request a free consultation, fill out the form above.