VAT (value added tax) is an indirect tax levied on most goods and services in the UK. When a VAT-registered business sells a product or service to another business or a non-business customer, it adds VAT to the price. This is known as the 'output' tax. There are three rates of VAT that can be applied, depending on the goods or services the business provides. The rates are:
- Standard (20%) - most goods and services, for example, accountancy fees
- Reduced (5%) - for example, domestic gas and electricity
- Zero (0%) - for example, food and drink, donated items in charity shops
Some goods and services are exempt from VAT (for example, lottery tickets, museum admission fees) or fall outside the UK VAT system altogether(for example, tolls for bridges).
VAT-registered businesses can reclaim the VAT levied on goods and services that they have bought (known as the 'input tax'). But businesses that are not VAT-registered cannot reclaim VAT.
Registering for VAT
A business must register for VAT if it makes 'taxable supplies' (which covers most goods and services) and its turnover for the previous 12 months has passed, or will soon pass, the VAT threshold of £77,000 (as of 1 April 2012). Companies that export must also be VAT-registered.
Businesses can choose to register for VAT, even if they don't have to. This means that they must charge VAT on their supplies, increasing their prices; but it also means that they can reclaim the VAT they have paid on the goods and services they have bought. Many businesses choose to voluntarily register for VAT for this reason. The easiest way to register for VAT is online with HMRC Online Services.
VAT-registered businesses must file a quarterly VAT return with HMRC that shows their output tax and their input tax. If their output tax is more than their input tax, they must pay the difference to HMRC. If their input is less than their output tax, they claim the difference from HMRC.
The flatrate scheme is intended to make VAT more straightforward for smaller businesses. Businesses with a taxable turnover of less than £150,000 can calculate their VAT payments as a certain percentage of their total VAT-inclusive turnover. The exact percentage they use will vary according to their sector. IT contractors pay a rate of 14.5%, for example. The rate contains an allowance for the VAT that businesses have paid on their purchases so they can't reclaim for that separately.
The flat rate scheme saves small businesses the administrative burden of having to work out the exact VAT rate they paid on their purchases.
A final point to note is that businesses with turnover that exceeds £230,000 have to leave the scheme.
With standard VAT accounting, businesses pay cash on their sales even if their customers have not paid them. But businesses with a VAT-taxable turnover of less than £1.35 million can take advantage of the cash accounting scheme. Using cash accounting means they do not need to pay the VAT until their customer has paid them and, if the customer never pays, they never have to pay the VAT.
Businesses can use cash accounting until their VAT-taxable turnover exceeds £1.6 million.