Updated on June 7, 2022
HM Revenue and Customs (HMRC) collects the “consumption tax” known as value added tax (VAT) from businesses (HMRC). You pay it when you buy something or use a service.
However, VAT-registered firms have a lot of work to do because there are varying rates for different sorts of goods and services.
The good news is that you can claim VAT relief on your company purchases.
Putting it succinctly:
You have to charge VAT to your clients.
As a customer, you are charged VAT.
HMRC is entitled to the difference.
Of course, it’s more complex than that and there’s record keeping and other paperwork to contend with. Don’t panic—FreshBooks keeps all these transactions in order, ready for your quarterly reports to HMRC.
Here’s What We’ll Cover:
When Do I Have to Register for VAT?
You must register for VAT in the UK as soon as your company’s yearly taxable turnover reaches the level. For instance, the £85k threshold for the 2020-21 tax year is an example. You must register for VAT as soon as your turnover reaches that level. For the rest of the year, you must charge and pay UK VAT on all of your business purchases.
For some businesses, it makes financial sense to register for VAT even if they haven’t yet exceeded the taxable turnover threshold.
Every three months, you must file precise returns to HMRC detailing your VAT sales and purchases.
To keep your books in order, you must strike a balance between the two. As HMRC summarises: “If you’ve charged more VAT than you’ve paid, you have to pay the difference to HMRC. It is possible to recoup the difference in VAT paid and charged from HMRC.”
What Are the VAT Rates?
Goods and services fall into a variety of categories, with three distinct VAT rates, as well as those that are tax-free or otherwise exempt.
Let’s start with the things you don’t charge VAT on.
Exempt Goods and Services
You don’t need to register for VAT if your business only deals in exempt products and services. List of all goods and services and their VAT status can be found at this link. So that you can see where your company stands. Exempt products and services include, but are not limited to, some health care and hospice services, educational institutions, and public postal services. There is an unique VAT Notice for each of these, which includes information about their exemption status.
Outside the Scope
‘Outside the scope’ refers to products that are not included in the VAT system. Charity donations and hobby sales are examples of this type of activity. In addition, it applies to products and services purchased or used outside of the European Union (EU). There is no VAT to be paid on any of the things that fall outside of this scope, and hence no VAT relief can be claimed.
3 VAT Rates
All three VAT rates in the United Kingdom are standard, reduced and zero. VAT returns are required to track and submit all of these transactions to HMRC. In the event that you are VAT-registered, it is imperative that you pay the suitable VAT percentage rate.
Standard Rate VAT
The usual VAT rate is applied to most goods and services. The current percentage is set at 20%.
Reduced Rate of VAT
The lower VAT rate is presently set at 5%. “The circumstances of sale” could be a factor in determining whether an item is discounted. As an example, items like sanitary products, diapers, and car seats for children are always billed at the discounted rate. Mobility aids, on the other hand, are only eligible for the 5% discount if they are placed in the home of a person over the age of 60. It’s critical to focus on the fine print of the rules.
Zero Rate of VAT
This one is the most difficult to grasp. For the time being, it seems a little superfluous. Zero rate VAT goods and services are classified as ‘VAT chargeable’. Nonetheless, the VAT rate is a mere 0%. You don’t charge your consumers any more fees.
Zero-rate goods include:
Clothing and footwear for children
There are a lot of newspapers and books available.
Helmets for motorcycles
Merchandise sold to a VAT-registered European company
The majority of exports are sent to nations outside the European Union.
Once you register for VAT, you must keep track of and report zero rated goods and services sales on your VAT return.
“Rates can vary and you must apply any changes to the rates from the day they change,” says HMRC. The 0% interest rate makes sense in this context. VAT categories have been established by HMRC for all products and services. This makes it easier to adjust the VAT rates in the future. At any point, the government can announce that all standard rate VAT goods and services are now 21%. Maybe it’s because the 0% rate has suddenly gone up to 1%? Every VAT-registered business must implement this adjustment right away, and it is their responsibility to do so.
What Is the 2020 COVID-19 Response for VAT in the UK?
VAT reductions are part of the UK government’s emergency COVID-19 financial package. There will be a two-year transition period following the implementation of the measures, which were announced on the 8th of July. Tourism and hospitality enterprises can charge a reduced VAT of 5% on their goods and services between these dates. They are not required by law to pass on the savings to their clients.
Businesses “severely harmed by the closures and social distancing measures” are to be supported by the VAT decrease. It is relevant to:
All food and non-alcoholic beverages are served at restaurants, cafes, and pubs (alcoholic beverages are not included)
Restaurants that serve hot and cold cuisine to go
Hotels and various types of vacation lodging, such as campgrounds and caravan parks.
Zoos, theaters, and museums are all examples of tourist attractions.
Businesses having a yearly revenue of less than £150,000 are subject to a flat-rate VAT system.
The reduced VAT rate scheme should be discussed in depth with your accountant to ensure that your company satisfies all of the criteria and has all of the essential record keeping processes in place..
What Is the VAT Flat-rate Scheme?
VAT is paid or reclaimed based on the difference between what your clients pay and the VAT you pay on your business expenses outside of the VAT flat-rate plan. You need to keep track of a constantly shifting sum.
The VAT flat-rate plan is available to businesses with taxable revenue of less than £150,000. This means that the VAT rate you pay is set in stone. Your industry and if you fall under the “limited costs business” category affect the rate.
Taxpayers are simply required to pay HMRC the flat rate. Any additional VAT you charge is yours to keep. However, you are unable to obtain a refund of VAT paid on commercial purchases. Consult with your accountant about if this is an option that makes sense for your company.
What VAT Records Do I Need to Keep?
Addresses for both the business and the customer
This is the tax identification number assigned to your firm.
Product and service descriptions should be succinct but accurate.
When it comes to VAT, things get a little more tricky. Every item on an invoice should have the following information:
The unit price and quantity, excluding VAT VAT rate you’re applying
To be paid in total:
Is there a cash rebate?
Small enterprises, in particular, may find the process cumbersome if they are unfamiliar with it. To ensure you pay the correct amount of value added tax, it is important to keep accurate records. It’s a sign of your business ethics, as well.
Tax breaks and exemptions are a pleasant source of extra funds for small business owners. Many people find the procedure of claiming to be a turn-off. It’s good to know that you’ll be able to claim your VAT refund through the same process you’ve already used to file your VAT return.
Let’s start with the bad news first. You can’t claim VAT on several products, such as:
VAT-exempt purchases include goods and services that are not used for commercial purposes.
Amounts paid for client meals or services purchased from an EU country Amounts received as part of a transfer of a going-concern business
Items purchased under a VAT second-hand margin arrangement are exempt from VAT.
Now for the good news. In addition to the items listed above, you may be able to claim back VAT on most purchases you make for your business. It is possible to claim the business portion of a vehicle if it is used for both business and private purposes.
And that’s not all! There’s more wonderful news! It’s possible to claim VAT on purchases you made before your company was VAT registered. HMRC, of course, has its own set of rules. Nothing less would have been acceptable to us.
In order to meet the first pre-VAT registration rule, you must make purchases at the right time. Only purchases made up to four years prior to the date on which you become VAT registered can be claimed as a refund. Then you must still own or have used those items to make other items that you currently own. For the first six months after you began charging VAT, you can go back and adjust the cost of services.
Additionally, purchases must be related to your current VAT-registered “business purpose.” This means that the new products or services must be directly related to the ones you’re already selling.
An invoice or receipt with the purchase date and a brief description is required. You should also keep track of how they are currently being used in your company. Your initial VAT return should include these claims for backdated VAT, together with your Box 4 calculation.
Assets Worth Over £50,000
A new set of guidelines applies to business assets costing more than £50,000. It applies if you’re purchasing a single piece of technical equipment or a boat, ship, or plane that costs more than £50,000 excluding VAT. Prior to VAT, if you buy property or land that costs more than £250,000.
Having a ship as a business expense is a fantastic opportunity. The Capital Goods Scheme can also be used to spread out your VAT rebate across several years.
Reporting VAT to HMRC
You submit a VAT Return to HMRC every three months. Each of these quarters is known as a ‘accounting period.’ Every VAT return is a detailed record of all your VAT sales and purchases for that three month accounting period. All VAT-registered businesses must submit VAT Returns, even if they don’t owe any VAT or have any to reclaim.
They must show all your figures for:
Total VAT you’ve charged your customers
Total VAT you’ve paid on your purchases
How much VAT you owe HM
How much VAT return HMRC owes you
Good to know: HMRC normally has your VAT return to you within 10 days.
HMRC expect most firms who are registered for VAT to submit their VAT return online. You must file your VAT return and pay any VAT you owe one calendar month and seven days after the end of your accounting period. As expected, there are financial consequences for missing submission and payment deadlines.