There are lots of decisions small businesses need to make as they start to grow, one of which is whether or not to register for VAT. It’s a legal requirement in the UK once any business reaches a turnover of £85,000 (though there are exceptions), but some small businesses choose to register before they are legally required to. Why? There are some advantages. See more about how VAT can affect your small business here.
This article takes a look at the pros and cons of VAT registration for a small business. Let’s start by defining what VAT is.
The term VAT is short for ‘Value Added Tax’. Most people are aware that VAT is a form of taxation levied on goods and services. It is a tax on the things we buy. Businesses charge VAT on the goods and services they sell and pay VAT on the goods and services they buy in.
The standard rate of VAT is 20 per cent, but certain goods and services have different VAT rates. The reduced rate of VAT is 5 per cent (sanitary products, energy saving measures, children’s car seats) and a small number of goods and services are exempt from VAT completely, charged at zero per cent (most food, newspapers and children’s clothing).
Why do we have VAT?
VAT is one of the biggest forms of revenue for the government. Other taxes on different forms of consumer spending include:
- taxes on alcohol and tobacco
- petrol, diesel and other fuel
- goods from abroad (if over customs allowance)
What are your VAT responsibilities?
As with any form of tax, there are plenty of rules and restrictions. It is common for many businesses to outsource the task of administration of VAT, preferring to let a professional with experience in this area process returns and ensure compliancy. You will need to be meticulous at record-keeping if you are processing VAT returns yourself.
Chartered accountants and small business advisers, OS Accounting, say that VAT is one of the most complex taxes small businesses have to deal with and that the biggest challenge for small businesses now is meeting the challenge of Making Tax Digital. VAT is the first tax moving onto an online reporting system this year.
VAT is only a legal requirement when your VAT taxable turnover for the previous 12 months exceeds £85,000 (as per HMRC guidelines 2017/2018). At this point you will need to register your business for VAT. See how here.
However, some businesses choose to register for VAT before they reach this level. Why they do this is explained in the pros section of VAT registration for small businesses below.
There are specific VAT rules for certain types of business, such as builders and charities that affects how VAT is accounted for, how much is paid and how much can be reclaimed. If you are unsure about your VAT obligations it is best to speak with your accountant and/or HMRC.
Forthcoming changes to VAT return requirements mean that most VAT registered businesses will need to keep digital records and submit quarterly VAT returns online from April 2019.
The pros of VAT registration for small businesses
- The ability to apply VAT to the sale cost of almost all goods and services
- VAT can be reclaimed on VAT returns for most of the business’s purchases
- Businesses can appear bigger than they actually are – customers, investors and suppliers will assume turnover is over £85,000 if the business is VAT registered
- Having a VAT registration number on business correspondence can add credibility to a business
- There are cashflow planning opportunities regarding VAT payments
- Potential gains possible through the Flat Rate Scheme (FRS)
The cons of VAT registration for small businesses
- Business or profits may be affected if customers are unable to recover VAT
- Impact on cashflow
- Additional administration
- Penalties if errors are made
The biggest disadvantage for small businesses with regards to early VAT registration is the fact that VAT gets added to prices and this means customers will be paying 20 per cent more. It may cause some customers to take their business elsewhere. Some businesses keep their prices the same, but this can have a negative impact on profitability.
Remember, you have no choice about registration once your turnover reaches the qualifying level (currently £85,000).
What is the VAT Flat Rate Scheme?
The VAT Flat Rate Scheme is a government incentive designed to simplify taxes. The amount of VAT a business pays or claims back from HMRC is usually the difference between VAT charged and VAT paid. With the Flat Rate Scheme, you pay a fixed rate of VAT. The scheme is offered to businesses with a taxable (VAT) turnover that doesn’t exceed £150,000. Speak with your accountant for advice on whether or not this scheme is right for your business.