Value Added Tax (VAT) part 1 – basics

Part 1. – VAT basics

Value Added Tax (VAT) is, not surprisingly, a value-added-tax, which is ultimately paid by the end user, usually the public. It is a very important tax as it raises a substantial amount of the country’s total tax revenues. The latest figures available (2017/18) show 18% of total tax revenue will come from VAT.

18% of total revenue will come from VAT

Source: Institute for Fiscal Studies

Businesses must register for VAT if their turnover (sales) exceeds £85,000 in any 12-month period, this is not a business year-end thing it is any 12 consecutive months. You also need to register for VAT if you expect your business to exceed the threshold in the next 30 days (ie a big sales order has come in that will push you over the threshold) This way HMRC will get the VAT on your big order. Once your business breaches the £85,000 threshold you must register your business for VAT with HMRC within 30 days. You can register for VAT online (https://www.gov.uk/vat-registration/how-to-register) or by post using VAT1 form. You must start paying VAT to HMRC from the date HMRC registers your business for VAT, but you can’t charge VAT to your customers until you get your VAT Registration Number. HMRC recommend you increase your prices to cover the VAT (multiply by 1.2) explaining the increase to your customers. When you receive your VAT Registration certificate with your VAT number on it you reissue the invoice with the VAT split out and with the VAT registration number on it. Your VAT registration number must be on all sales invoices and sale receipts you issue. You can voluntarily register for VAT even if your business is under the VAT registration threshold, some businesses do this for credibility believing their business looks more established being VAT registered, other businesses voluntarily register because their customers will only deal with VAT registered businesses, this often happens with public sector contracts with councils etc. You can de-register for VAT if your businesses turnover is expected to drop below £83,000 in the next 12 months, HMRC must accept your turnover is likely to drop below the de-registration threshold. VAT works on the principle that VAT is charged on the sale and reclaimed on the purchase (netting off) until it reaches the final customer. For example (assume all businesses are VAT registered) –

A Timber company sells wood to carpenter for £100 plus VAT (£120)
The Timber Co keeps £100 and pays HMRC £20 VAT

The carpenter makes a table from the wood and sells it to a shop for £200 plus VAT (£240)
The carpenter keeps £200 and owes HMRC £40 on the sale, but the carpenter can claim back from HMRC the £20 VAT he paid the Timber Co, so the Carpenter pays HMRC £20.

The shop sells the table to a member of the public for £400 plus VAT (£480)
The shop will keep the £400 and owes HMRC £80 from the sale but the shop paid the carpenter £40 VAT on the purchase of the table, so the shop pays HMRC the difference of £40 VAT.

Ultimately HMRC has received £80 VAT which has been suffered in full by the end user (member of the public). In the above example we have assumed all the VAT is at standard rate VAT 20%, but there several different VAT rates –

  • 20% Standard Rate – On most goods and services
  • 5% Reduced Rate – On certain goods like Children’s car seats, Home energy etc
  • 0% Zero Rate – On things like most foods and children’s clothes Exempt (No VAT) – Postage stamps, Financial & Property transactions
  • Outside the scope – For example where one VAT registered business sells a going concern business to another VAT registered business

Although Zero Rated and Exempt have the same VAT outcome (nil VAT charged) there is an important difference, with Zero rated VAT sales you can claim the VAT back on your purchases, with exempt VAT sales you can not claim the VAT back on purchases. Where a business makes some VAT sales and some exempt sales this is called Partially Exempt for which there are a whole raft of different rules.

This article is intended to only give an overview of VAT, but VAT is very technical and can be complicated, if your business becomes involved with VAT you should always double check with your accountant.

Burton Mail – Wednesday 6 June 2018. Next month we will look at the different types of VAT schemes and what would be most suitable for your business.