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.