VAT, an abbreviation for Value Added Tax, is a tax that affects every single person in the UK. This is because it is added to most of the products and services that we buy. But why do we pay VAT and what do you need to know about this tax?
In this article, we’ll explain everything you need to know about VAT, from what exactly it is to where it goes when you pay it, and what happens if you don’t pay it.
What is VAT?
VAT is a sales tax which must be charged by VAT registered traders. The amount of VAT that is charged will depend on the value of the goods or services that are being supplied.
Every business that has a turnover above the VAT threshold must register to pay VAT. This sales tax should then be charged to customers whenever a VAT-chargeable product or service is purchased, and the money is handed over to HMRC – HM Revenue and Customs.
However, not all businesses are required to register for VAT. Only those who earn above the VAT threshold must be VAT-registered. Nevertheless, many businesses choose to register for VAT voluntarily. You might wonder why a business would voluntarily choose to pay a tax – we’ll cover that later.
Read on to learn more about VAT, including how much you need to pay, how you know if you need to register and why you might consider registering to pay VAT voluntarily.
Who pays VAT?
Whilst it is the business itself that is responsible for handing over VAT payments to HMRC, you might be surprised to learn that the money itself actually comes from the end customer. This means that the business is simply a go-between that sits between HMRC and the end customer.
The VAT threshold currently sits at £85,000. This figure is reviewed each year, so it’s important to check the government website to ensure that you’ve got the most up-to-date information. When your turnover (that’s your gross sales, not your profit) exceeds this figure, you’ll need to begin paying VAT.
HMRC states that you should register for VAT if you expect your turnover to exceed £85,000 in the next 30 days, or if your business had a turnover of more than £85,000 over the previous 12 months.
Once you’re registered for VAT, you’ll then begin adding the tax onto your VAT-taxable products and services. The customer will pay that tax to you, and then you’ll be responsible for handing that money over to HMRC.
So, being VAT registered won’t increase the amount of tax that you pay as a business, but it will increase the price that your customer pays.
What rate is VAT charged at?
The standard rate for VAT in the UK is currently set at 20%. This rate increased in January 2011, before which it was set at 17.5%. However, not every product or service will be subject to the full VAT rate of 20%, so there are some other VAT rates that you will also need to be aware of.
Let’s take a look at the different rates of VAT in the UK.
Standard rate VAT
The majority of goods and services fall under standard rate VAT. This includes anything that could be seen as a luxury, which is why ice cream, confectionary and crisps fall into standard rate VAT despite other food products being zero-rated.
Reduced rate VAT
There are also some items which are subject to a reduced rate of VAT, which is charged at 5%. These items include sanitary products, household fuel and children’s car seats.
Zero rate VAT
Some products and services are known as ‘zero rate’ when it comes to VAT, meaning that no VAT is charged on these items. This includes most foods, children’s clothes and books. Although you do not need to charge VAT on these items, you will need to record them to be reported on your VAT return as zero rate goods.
If as a business you only trade zero rate goods and services, you may be able to apply for an exemption from VAT registration from HMRC. However, this will also mean that you will not be eligible to reclaim any VAT from your business expenses.
There are some products and services which are exempt from VAT. This means that you do not need to charge VAT on these items, or to report them in your VAT taxable turnover. VAT exempt products and services include insurance, training, property, medical products, dentistry and postage stamps.
A business that only trades in VAT exempt goods and services will not need to register for VAT. Once again, this means that you will not be eligible to reclaim any VAT that you pay on business purchases.
Do I have to pay VAT if I am self-employed?
Being self employed does not automatically mean that you need to begin paying VAT. The only businesses that are required to pay VAT are those that are VAT registered traders. This usually happens when a business’ turnover crosses the VAT threshold, although a business can also choose to register for VAT voluntarily.
It’s important to regularly check whether you should be paying VAT, especially if you are close to the threshold. There are two ways in which you should do this.
Each month you should add up your VAT-taxable turnover for the month. That’s your income for all sales that would have been subject to VAT. You should then create a 12 month running total of your VAT taxable turnover. If that total reaches £85,000 (the current VAT registration threshold), you’ll need to register for VAT by the end of the next month.
If you suspect at the start of a 30 day period that your VAT taxable turnover is going to exceed £85,000, you will need to register for VAT immediately.
As soon as you are registered for VAT, you will need to start adding VAT to your invoices. You will also need to complete VAT returns to pay the money over to HMRC.
Some businesses choose to register for VAT voluntarily, despite their sales not exceeding the current VAT threshold. We call this voluntary registration. This enables the business to enjoy the benefits of being VAT registered, without needing to meet the threshold for registration, such as claiming VAT relief on business expenses.
Benefits of being VAT-registered
Whilst charging your customers VAT and needing to complete VAT returns may sound like a chore, you may be surprised to learn that there are actually many benefits of being VAT-registered. That explains why a business would choose to register for VAT voluntarily!
Let’s take a look at some of the benefits of registering your business for VAT.
Cost savings of VAT registration
VAT registered businesses are able to claim back VAT that they pay on business expenses and purchases. This means that if you’re selling to other VAT registered companies, they will be able to claim back the VAT that they pay to you. You can then reclaim that VAT that you pay on your own business expenses, helping to increase your profits and minimise your costs.
However, it’s important to note that if your end customer is not VAT registered, adding VAT will push the prices up and reduce the number of potential sales that you make. If your business is B2C, you will need to carefully consider your options before deciding to register for VAT voluntarily.
The effect of VAT registration on reputation
You might be surprised to learn that becoming VAT registered may help to increase the reputation of your business. This is because many people see VAT registered businesses as having more credibility and being a more stable company. They may assume that your turnover is more than £85,000, making you a larger company. This could increase your chances of winning contracts and further increasing your turnover.
Backdating VAT reclaims
Not only can VAT registered companies reclaim VAT on future purchases that they make, but you can also claim back VAT on purchases that you made before you registered. Providing you still own the items in question, you can reclaim VAT on purchases that you made up to four years before your VAT registration. This represents a significant cost saving for many businesses.
What happens if you don’t pay VAT?
It’s vital that you register for VAT when you reach the VAT threshold, and that your VAT returns and payments are sent on time. But what happens if you don’t register for or pay VAT?
If your business has a turnover that exceeds the VAT threshold (currently set at £85,000), you must register for VAT as soon as possible. If you fail to register for VAT in the required time period, you may be given a fine by HMRC. This fine will depend on how much VAT you owe, as well as how late you are with the registration.
Once you’re registered for VAT, you will need to submit your VAT returns on time – usually every three months. If you don’t submit your VAT return on time, or if you don’t pay the full amount of VAT by its due date, you may receive an automatic surcharge.
The penalty you’ll receive will depend on the amount of VAT that you owe. If you’re struggling to pay your VAT bill, you should contact HMRC as soon as possible. It’s also best to pay anything you can to reduce the amount of VAT that you owe, as this will reduce the penalty that you receive.
How to register for VAT
If it’s time for your business to register for VAT, you may be wondering how you go about this. For the majority of businesses, you can register for VAT online through the HMRC website. This involves creating a VAT online account which you will then use to submit your VAT returns.
If you have an accountant, you can appoint them to submit your VAT returns on your behalf, and to deal with HMRC o9n behalf of your business.
After you’ve registered for VAT, you will receive a VAT registration certificate within 30 working days. This will usually be sent to your VAT online account, although it may also be sent via post if you have been unable to register online.
Is paying VAT necessary?
Paying VAT is necessary for all businesses that have a turnover that exceeds the VAT threshold. This is currently set at £85,000 in the UK. If you fail to register for VAT, to submit VAT returns or to pay VAT that is due, you may receive a fine from HMRC. This fine will depend on how late you are registering for VAT or paying VAT, and how much VAT you owe.
What happens to the money that we pay on VAT?
You might be wondering what actually happens to the money that you pay for VAT. The fact is, VAT is paid to HMRC in the same way that all other taxes are. This money is then used by the government for health, welfare, education, transport, defence and all of the other things necessary to successfully run a country.
VAT, or Value Added Tax, is a sales tax that applies to businesses with a turnover that exceeds the VAT threshold. This threshold currently stands at £85,000. VAT is added to invoices generated by the VAT registered company and paid by the customers of that company. The business must then complete regular VAT returns, paying the VAT to HMRC.
Whilst most goods and services are subject to the standard rate VAT at 20%, some items such as sanitary products and household fuel are subject to a reduced rate of 5% whilst items such as children’s clothing and food products are zero-rated.
If you’re unsure about your obligations when it comes to paying VAT, it’s always best to consult a qualified accountant. They can talk you through your responsibilities and help you to decide whether now is the time to register your business for VAT.