Updated: Sep 26, 2019
One of the biggest milestones for small businesses is hitting the VAT threshold, but a lot of very small businesses aren't quite sure what that is or what it means for them. You might know that I have a Facebook group called Bookkeeping for Startups where I answer questions about things like this, and one of the members said to me when she joined that as a small business, she didn't understand what VAT was or whether she should be including it on her invoices. With this in mind, I thought VAT would be a great subject for a blog post, to help those businesses who need to know whether they indeed need to worry about VAT.
What is VAT?
Before we go any further then, VAT stands for Value Added Tax. It's known as a "consumption tax" and what that effectively means is it's a way of taxing spending in the economy. Ultimately it targets the end user of a good or service, whether that end user is an individual or a business and I suppose you can look at it as quite a clever way for the government to influence spending in the economy to some extent.
Most countries have some kind of VAT, and in the UK different types of goods attract different rates of VAT. Generally essential goods and services don't attract VAT - basic foods and travel on public transport being good examples, some (very few) goods and services attract a lower rate of VAT, you might have noticed for example that you only pay 5% on your energy, whereas other goods and services attract the standard rate of VAT which is currently 20% in the UK.
How do HMRC get paid?
VAT registered businesses are responsible for collecting VAT and paying it across to HMRC. VAT registered businesses have to charge VAT at the appropriate rate to their customers (usually 20% but it depends on what you're selling) and keep track of how much VAT they've paid VAT registered suppliers. They pay the difference between the VAT they've received from customers and VAT they've paid to suppliers to HMRC every time they do a VAT return, which is usually quarterly.
When do you need to become a VAT registered business?
Businesses need to register for VAT once their turnover over a 12 month rolling period hits the VAT threshold (£85,000 at the time of writing). This applies whether you're a limited company, partnership, sole trader or any other type of organisation.
Turnover means your sales figure, so regardless of your profit levels, you need to keep track of how much you're selling each month, and how much you've sold over the past 12 months (sorry to keep on about it but this means the actual past 12 months and not your financial year) as you're obliged to register for VAT within one month of hitting that threshold.
Can I claim VAT back if I'm not VAT registered?
We all pay VAT on the VAT registered supplies we buy, and if you're not VAT registered then the unfortunate fact is that you can't claim VAT back. Some businesses choose to register for VAT voluntarily if they're paying a lot of VAT out and there are various factors to consider if you choose to do this. I'd certainly recommend speaking to an accountant or bookkeeper if you're thinking of going down this route.
What will I need to change in my business if I register for VAT?
If you register for VAT, the main things to keep in mind are that you'll need to make sure you're issuing VAT invoices and VAT receipts with the correct information on them, you'll need to submit a regular VAT return to HMRC (usually quarterly) and make a payment to HMRC at that time. You'll need to keep proper records of VAT charged to customers and VAT paid to suppliers and if you're not already keeping good accounting records it's important to speak to a bookkeeper or accountant right away.
Making Tax Digital
Finally, a word on Making Tax Digital (MTD). From 1 April 2019, VAT registered businesses will need to submit their tax returns electronically using MTD-compliant software. The big-name accounting software firms are set up for Making Tax Digital, but if you're not yet VAT registered but likely to be soon, you should definitely keep in mind that the way VAT returns will be submitted is changing very soon. The best way to be sure you're doing what you need to be doing and that you're MTD-ready is to check with your accountant or bookkeeper.
So in answer to the question "do I need to worry bout VAT?" I'd definitely say there's no need to worry, but you should be aware of it, and know what you duties are and when they will kick in. There's lots of helpful information on HMRC's website about how VAT works, who needs to register and how to register but if you're not sure, speak to your bookkeeper or accountant who will certainly be able to help.