If you own a business, you might already be familiar with VAT and the many rules and regulations that come with it. In this article, you will learn everything you need to know about value-added tax, so it will no longer be as scary and problematic as it might seem at a glance.
Remember, if all of this still seems too complicated for you, your safest bet would be to find a professional accountant that will help you manage the tricky world of business finances.
With that being said, here is what you should know.
What is VAT?
VAT stands for value-added tax. It is charged when a VAT registered business sells goods or services. It is a sales tax collected by companies on behalf of the government.
Both businesses and consumers should pay VAT, whether it’s a manufacturer purchasing raw material or a customer making a direct purchase from a company.
How does VAT work?
Vat can be considered a type of sales tax representing the value being added to a product between a supplier and the buyer.
The significant difference between it and the sales tax is that the latter is paid once—when the item is sold. Unlike it, VAT has to be paid every time the item is sold—from manufacturer to wholesaler to retailer to customer.
VAT is usually forwarded to the customer. This is so companies can simply reclaim the VAT they pay to the government in doing business.
Is everything subject to VAT?
VAT is not all-encompassing. Some services are entirely exempt from it, such as education, and some are zero-rated, for instance, books. There’s also a reduced rate of five percent for certain consumer goods, including fuel and energy-saving products. If you sell only goods that are deemed exempt, then you don’t need to register for VAT.
In general, there are three rates of VAT. The rate to be charged by the business is predetermined based on the item that is being sold or the service being offered. The rates are:
- Standard rate at 20% – this applies to the majority of goods and services.
- Reduced rate at 5% – gas and electricity used in the home, for example
- Zero rate at 0% – includes books and newspapers, children’s clothing, public transport, and most food (excluding meals-in and takeaways).
Who pays VAT?
All businesses must register and account for VAT if their taxable turnover, i.e., all sales that are not exempt from VAT in any previous 12-month period, exceeds the VAT threshold. The current point is £85,000, and it will stay this way until at least the 1st of April 2022.
You must also register for VAT if you expect your turnover to go over the threshold in the next 30 days or if you take over a VAT registered business as a going concern. Finally, this obligation applies to you if you sell goods into the UK from another EU country and exceed the “distance selling threshold,” which is currently £70,000.
Additionally, you can register voluntarily below this threshold even as an entrepreneur if it is beneficial to you. If the clients you serve are mainly VAT-registered, then it’s worth becoming one too. Your clients won’t see the VAT as an administrative chore as they will be in the habit of claiming back the VAT.
How will VAT affect your customers?
When you become VAT registered, you will need to start keeping VAT records showing details of the VAT you have been charged and the VAT you have charged your customers.
If the customer themselves is VAT registered, they will be indifferent to your VAT status as any VAT charged to them can be reclaimed (rules do apply here, though, as some VAT charged is non-reclaimable, e.g., VAT on a car purchase). However, when you are in business and selling to a private customer, then they are unable to reclaim the VAT, which makes you now more expensive and possibly less competitive. This is because the price that your customer pays will automatically increase.
Benefits of being VAT-registered
Many business owners believe dealing with VAT is a hassle. However, there is no denying that being registered can offer benefits as well. For instance, many businesses will only deal with VAT-registered companies, which means you have a wider pool of options available to you.
Besides, registering for VAT can offer credibility to your business since it creates the image that your company is more extensive than it is. You receive a VAT number displayed on invoices, on your website, and any documents used. This is appealing to many potential customers because it helps you be seen as more trustworthy and professional.
You can also reclaim VAT on expenses for your company, such as accountancy fees and computer equipment.
