VAT can be one of the most baffling areas of accountancy for business owners. So we have put together a beginner's guide to value added tax to help you on your way.
What is it?
VAT stands for Value Added Tax and put simply, it is a tax on the things that we buy.
Like any tax, it's a source of revenue for public spending, generating a lot of money for the government.
In fact, VAT is quite a big proportion of the UK government's income.
How does it work?
In the UK, the HMRC holds and manages the registry of sellers who can charge and claim VAT.
When a registered seller makes a sale, they add tax onto the price of that transaction – that’s the Value Added Tax.
The exact amount to be added is calculated using 'the rate of VAT' which is a percentage of the 'price before tax' – in other words, the price that would have been charged if there was no tax on it.
How much do you pay?
There is more than one rate of VAT, but the most common one is the Standard Rate which is applied to most types of goods and services.
The Standard Rate is 20%. This was temporarily lowered to 15% in 2008 during the recession to help declining consumer confidence. However, in January 1 2010 it returned to the original rate of 17.5%, and as of January 4 2011 it was increased to 20% in an effort to lower the UK’s budget deficit.
Another rate, the Reduced Rate, applies to things like the installation of energy saving materials or women's sanitary products. This is set at 5%.
There are also other supplies that are zero-rated – which include most food (but not restaurant or takeaway meals), children’s shoes and clothing, prescriptions, books and newspapers, new house sales and prescriptions.
How will I know when to register for VAT?
If you've just started in business or have a relatively low turnover, you’re not required to register for VAT. This means you can't reclaim the VAT you pay when you purchase goods and services.
You will need to register for VAT if your business grows and annual sales of taxable goods and services reach the £82,000 VAT threshold or you expect a taxable turnover of more than £82,000 in the next 30 days.
Registering for VAT means you need to charge your customers VAT.
But if your customers are VAT registered businesses they can reclaim the VAT you have charged.
It also means you can reclaim any VAT you pay when you buy goods and services for your business.
Rather than paying HMRC all the VAT you collect from your customers, you first deduct the VAT you have been charged on the business supplies you have bought.
Even if you are under the VAT threshold, registering for VAT might boost your profits and can give your business the appearance of being bigger and more established.
The business of VAT
Once you've registered for VAT you will need to start keeping VAT records - details of the VAT you have been charged and the VAT you have charged your customers.
Rather like keeping other tax records for the HMRC, you need to be meticulous about VAT book-keeping.
You need to record all your business transactions, and keep documents including bank statements, bills, receipts and cheque stubs to back them up.
You also need to separate your business transactions from your personal finances.
For VAT purposes, you must keep a record of all the supplies you make and receive, and a summary of VAT for each tax period covered by your tax returns.
Records must be up to date and easy to find, and if you register for VAT you must keep your records for six years.
Many businesses choose to employ an accountant or at least a book-keeper at this stage, to take the headache out of paperwork and leave them time to get on with running their business, especially since there are severe penalties for failing to keep records.
If you would like our help with this – or any other aspect of running your business, give us a call today.