What is VAT?

VAT (Value Added Tax) is a consumption tax levied on the value added to goods and services at each stage of production or distribution. It is collected by businesses on behalf of the government and applies to most goods and services sold in the UK and European Union (EU), as well as in many other countries worldwide.

Businesses charge VAT on their sales (output tax) and can reclaim the VAT they’ve paid on purchases (input tax).

• Standard Rate: 20% (in the UK)
• Reduced Rate: 5% (for certain goods like energy-saving materials, children’s car seats)
• Zero Rate: 0% (for items like books, newspapers, children’s clothing)

VAT Return

A VAT return is a document submitted by VAT-registered businesses to report the amount of VAT they’ve charged on sales (output tax) and the VAT they’ve paid on purchases (input tax). It is typically filed quarterly. The difference between the VAT charged and the VAT paid is either paid to or reclaimed from HMRC (Her Majesty’s Revenue and Customs).

The VAT return includes:

– VAT on Sales: How much VAT the business has collected from customers.

– VAT on Purchases: How much VAT the business has paid to suppliers.

– Total VAT payable to HMRC or Reclaimable VAT: This is the difference between VAT collected and paid.

VAT Accounting Schemes

VAT accounting schemes are designed to simplify the VAT process for certain businesses, allowing them to handle VAT differently based on their size or type of business. These schemes are:

– Standard VAT Accounting: Businesses charge VAT on sales and can reclaim VAT on purchases. VAT returns are submitted quarterly.

– Flat Rate Scheme: This scheme simplifies VAT for smaller businesses by charging a flat percentage of their turnover as VAT, rather than calculating VAT on every individual sale and purchase.

– Cash Accounting Scheme: VAT is only paid when payment is actually received (not when the invoice is issued), helping with cash flow. This is helpful for businesses with customers who may delay payments.

– Annual Accounting Scheme: Instead of quarterly VAT returns, businesses make nine monthly or three quarterly advance payments and file a single annual VAT return. A final balancing payment is made after the return is submitted.

Registering for VAT

Businesses must register for VAT if their VAT-taxable turnover exceeds the VAT threshold. In the UK, as of 2024, this threshold is £85,000. Voluntary registration is possible even if the turnover is below the threshold, which can be advantageous for businesses that incur significant VAT on purchases.

– Compulsory Registration: If the business’s taxable turnover exceeds £85,000 over a 12-month rolling period.

– Voluntary Registration: Businesses below the threshold can register voluntarily to reclaim VAT on business purchases.

Paying VAT

Once registered, businesses must:

– Charge VAT: Businesses charge VAT on their sales (output tax) and provide VAT invoices.

– Submit VAT Returns: Quarterly returns report VAT charged and VAT incurred.

– Pay VAT: If output tax exceeds input tax, the business pays the difference to HMRC. If input tax exceeds output tax, the business can reclaim the difference.

VAT payments are made either quarterly (after filing VAT returns) or through advance payments (in schemes like the Annual Accounting Scheme).

Flat Rate Scheme (FRS)

The Flat Rate Scheme is designed to simplify VAT accounting for small businesses with an annual turnover of less than £150,000 (excluding VAT). Under this scheme, businesses pay a fixed percentage of their turnover as VAT, and they don’t reclaim VAT on most purchases.

– The flat rate percentage depends on the type of business and varies by industry (e.g., retail, food services).

– Businesses in the Limited Cost Business category, where the cost of goods is less than 2% of turnover, must pay a higher rate (16.5%).

The Flat Rate Scheme is easier to manage but may result in businesses paying more VAT than under standard VAT accounting, depending on their input VAT costs.

Summary of Key VAT Concepts

– VAT is a tax on goods and services that applies at every stage of production and is ultimately borne by the final consumer.

– VAT returns report VAT charged (output tax) and VAT paid (input tax) and determine the net payment or refund.

– VAT accounting schemes are designed to simplify VAT for businesses with different needs (e.g., cash accounting, annual accounting, flat rate).

– VAT registration is compulsory if turnover exceeds £85,000, and once registered, businesses must comply with VAT charging, record-keeping, and return-filing requirements.

– The Flat Rate Scheme simplifies VAT payments for smaller businesses by applying a fixed rate to total sales, reducing the complexity of calculating VAT on individual transactions.

VAT is essential for business compliance, and choosing the right accounting scheme can help businesses manage their cash flow and administrative burden.