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VAT – The Basics

A basic introduction to Value Added Tax (VAT)……………………

 

What is VAT?

  • Value Added Tax (VAT) is a consumer tax which is added to the ordinary selling price of an item or service.
  • Ultimately it is the end consumer who pays the tax.

 

Does it apply to me?

  • If your company sends out sales invoices of over £77,000 in a 12 month period you MUST be registered for VAT.
  • This threshold applies for both Limited Companies and Sole Traders.
  • Companies and sole traders can also choose to become VAT registered even if they don’t have to.

 

Why would I register if I don’t need to?

  • When companies or sole traders think it is likely they will pay more VAT on purchases than they will add to sales invoices it is worth them registering for VAT.
  • This is because they could actually get a refund from HMRC for some of the VAT they have paid, each time they report what has been charged and paid.
  • Sometimes companies or sole traders will register at startup because they think they might get to the threshold in the future and want to start in the way they will continue rather than having to add up to 20% to their invoices in a year or so.
  • Having to add VAT, where previously you hadn’t, can be off-putting for your customers when the majority of people buying your goods are not VAT registered themselves.

 

How does it work?

From the VAT registered selling company’s perspective:

  • The VAT registered seller applies a percentage to the normal selling price of whatever item or service is being sold. This percentage is the relevant VAT rate.
  • The VAT is then added to the total of the invoice which must be paid by the buyer.
  • So the invoice will be made up along the lines of the following example:

Value of goods being sold by the seller                    £100       = invoice net value

VAT at 20% (£100 x 20%)                                           £20        = VAT

Total amount being charged to the buyer             £120       = invoice gross value

  • The selling company will pass on the VAT paid by the buyer to HMRC.

Note: if your company is not VAT registered you MUST NOT add VAT to invoices.

From the buying company’s perspective:

  • The buyer pays the full (gross) value of the invoice to the seller.
  • If the buyer is VAT registered they can reclaim the VAT paid from HMRC.
  • If the buyer is not VAT registered then they are the end consumer and have paid the tax.

What are the current VAT rates?

  • There are 3 main rates of VAT.

1.    Standard Rate                  20%                        Applies to most goods and services.

2.    Reduced Rate                   5%                           Some goods and services, eg children’s car seats

and some energy-saving materials in the home.

3.    Zero Rate                           0%                            Some goods and services, eg most food and

children’s clothes.         

For more information on goods and services which are subject to the 5% or 0% rates, or for items which are exempt, see HMRC website     

 

When and how is VAT paid to or reclaimed from HMRC?

  • Every 3 months the VAT registered seller will complete a VAT return and submit this to HMRC.
  • A VAT return is a summary of the VAT charged on items sold and the VAT paid on items bought.
  • The VAT paid is deducted from the VAT charged to arrive at the amount of VAT which will need to be passed on to HMRC.

 

  • For example,

Seller has added to invoices total VAT of                                               £1,000   = output VAT

Seller has paid on purchases total VAT of                                             £   800    = input VAT

Total VAT to pay to HMRC (£1,000 – £800)                               £  200     = net VAT

 

  • The net VAT (in the example the £200) is then paid to HMRC manually via their bill pay system or by direct debit if this has been set up.

 

What if the VAT I have paid on items purchased is more than I have charged on the items I have sold?

  • Lucky you!
  • In this case you will be able to get a VAT refund from HMRC.
  • As above you would complete your VAT return but this time it may be more like this:

 

Seller has added to invoices total VAT of                                               £   800    = output VAT

Seller has paid on purchases total VAT of                                             £1,000   = input VAT

Total VAT to be refunded by HMRC (£800-£1,000)            -£  200   = net VAT

 

  • The net VAT will then be refunded by HMRC into your company bank account.

 

I think I will need to register for VAT but this does all sound complicated. Is there an easier way?

  • Yes, if your sales invoices are less than £150,000 you can register for the Flat Rate VAT Scheme.
  • The Flat Rate VAT Scheme very simply allows VAT registered sellers to pay HMRC a set percentage of the value of sales invoices they send out.
  • They still need to charge VAT on their invoices as any other VAT registered seller, but they don’t need to keep a track of this in their accounts.
  • Nor do they need to track what VAT they have paid on purchases.

 

I will go into a little more detail on the Flat Rate VAT Scheme in a future article. In the meantime you can find information on the HMRC website .

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