Finance, Tax & Admin

Understanding VAT

Business Advice | 3 August 2023 | 11 months ago

Though you will have heard of VAT, how much do you know about what VAT is and how it works? You need to be aware of what goods and services it’s added to, and which businesses need to be charging it to their customers. As a business owner, you need to stay on top of the rules surrounding VAT, and ensure that you are being compliant.

Understanding VAT

What is VAT?

VAT, or Value Added Tax, is a government tax added to the sale of goods and services in the UK, and it’s also commonly used in other countries throughout the European Union. It’s a type of consumption tax, because it’s only charged on items that people buy, but it’s also an indirect tax as it’s collected by businesses.

In the UK, businesses with a taxable turnover of more than £85,000 must register for VAT, and they must then charge VAT on their sales. The VAT collected is then paid to HM Revenue and Customs (HMRC) in the same way that other forms of tax. Businesses with a taxable turnover of less than £85,000 can choose to register for VAT, and some do, but this is not mandatory.

In the UK, VAT is charged at 20%, though this figure does occasionally change. For example, between 2009 and 2011 it was 17.5%, which rose from a rate of 15% in 2008 and 2009. When VAT was first introduced in 1973, it was charged at only 10%, before dropping to 8% for many years. Though VAT rates are not set to change any time soon, it’s important to be aware that change is possible when calculating what needs to be paid.

 

How VAT Works

The standard rate of VAT in the UK is 20%, and this is the rate that’s charged on most goods, services, commission and assets. For most things, a VAT rate of 20% will already have been added. However, there are a handful of items that have a VAT rate of zero. This rate applies to books and newspapers, children’s clothing and shoes, motorcycle helmets and most foods. The majority of goods that are exported from Great Britain to a country outside of the UK also have a VAT rate of zero. This is also the VAT rate for most goods that are exported from Northern Ireland to a country outside of the EU and UK. Though zero VAT is charged, businesses still need to report it on their VAT return at the end of the financial year.

Some items are exempt from VAT, including postage stamps and property transactions, but being exempt is slightly different to having a VAT rate of zero. As is the case with goods and services with a zero rate of VAT, no VAT is charged on these transactions, but they do not need to be included in a business’ taxable turnover.

 

The Purpose of VAT

One of the key reasons for adding VAT to many goods and services is to generate government revenue. VAT is a key source of revenue for the government, which helps to fund a wide range of public services and development. It’s considered to be a simple and straightforward way to handle sales tax and, as collecting and paying the VAT to HMRC is the responsibility of businesses, it doesn’t require anything of the consumer. Plus, as VAT does not apply to savings or investments, it could encourage people to save and invest their money, rather than spending it on goods and services.

 

The Advantages of VAT

As a business, you will need to register for VAT if your taxable turnover exceeds £85,000 but many businesses choose to do so before reaching that point. This is because there are a number of advantages of being VAT registered, such as having the ability to reclaim VAT. You can reclaim VAT on all goods and services you purchase. If you charge more VAT than you pay, you can claim it back through HMRC. It’s helpful if your business wants to invest in any expensive equipment. Being VAT registered also makes your business look good, as it implies that you are successful, profitable and established.

Registering for VAT also increases your cash flow, which can help your business to stay afloat. Charging VAT means charging more for your goods and services, which brings more cash into your business. This is something that investors and stakeholders look on favourably. There is also the advantage of more companies and clients wanting to work with you. A lot of people will only work with VAT registered companies, so registering opens up a lot of doors.

 

The Challenges of VAT

Of course, there are some challenges that come with being a VAT registered business. For example, calculating, collecting and paying VAT can be complex, especially if you are handling things yourself and not utilising the services of a professional. If you don’t comply or you get things wrong, you could be fined, and the mistakes can be difficult to put right. It can also be confusing when you are dealing with international businesses, as who you charge VAT to can change depending on their location. You might find it difficult to keep on top of how much VAT you should be charging and when, especially if you are working with businesses outside of the UK. Charging VAT can also increase your business’ costs throughout the production process. As VAT is calculated at every stage, businesses often end up paying more, and this cost then has to be passed on to the consumer.

If your business has a taxable turnover of less than £85,000 and you don’t have to register for VAT, you should weigh up the pros and cons before doing so. Though there are obvious advantages, it can make your bookkeeping and accounts more complicated.

 

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