VAT can be a tricky issue for many small business owners but is something they need to understand
Dealing with value added tax (VAT) is, for many small firms, one of many ‘necessary evils’ that accompanies running a business. Although it might make your head hurt, a decent understanding is essential in both compliance and financial terms.
VAT accounts for around 22 per cent of the tax receipts raised by the UK Treasury. It contributed approximately £115 billion in revenue in 2014/15. Therefore, while our current system has been shaped by European Union VAT Directive restrictions and could therefore be altered when the UK formally departs from the EU, it is unlikely that we will see major changes to it in the foreseeable future.
Any business engaging in economic activity can register for VAT, although this is only mandatory for those which are generating revenues of £83,000 per year or more.
Once a company is registered it is required to submit returns to HMRC on a quarterly basis, and pay them any VAT received in that period within one month and seven days.
It’s important for businesses to retain all invoices that are both raised and paid as these are needed to complete an accurate VAT return. All VAT invoices raised by a company must hold detailed information including their own as well as their customer’s name and address, VAT number, the tax point, details of the supply being made, and the net and VAT amounts being charged. These records are maintained as part of a VAT account and must be kept on file for six years.
Depending on the size of a business and the type of work it does, there may be some alternative options available which simplify the level of administration and record keeping involved with VAT.
The flat rate scheme simplifies the accounting process by making VAT payable as a single fixed percentage applied to gross turnover. This also usually results in a company having to pay less to HMRC. The scheme may be suitable for one or two-person service businesses which turn over up to £150,000 per year and bill their clients for a much higher proportion of VAT than they pay out on goods or services.
Using this scheme, HMRC charge a reduced rate to businesses (discounted by a further one per cent in the first year) which is applied to the quarter’s gross billings to clients.
Larger SMEs that turnover up to £1.35 million annually can consider the cash accounting scheme (CAS) or the annual accounting scheme (AAS). The former enables smaller businesses to defer payments of tax liabilities, only paying out VAT after they have had their invoices settled. There is no formal application required to join the CAS and businesses can begin to use this scheme without notifying HMRC.
Meanwhile AAS requires businesses to complete only a single VAT return each year, so alleviating administrative burdens and helping them to better manage cash flow. A fixed interim payment is then required, with qualifying companies given an extra month to submit the return and pay tax due followed by an annual balancing payment.
Start-up businesses that require an extended development phase with little or no revenue generated can certainly benefit from voluntary registration as this allows them to reclaim their VAT back on expenditure. VAT monthly returns as opposed to quarterly submissions can also increase cash flow to fledgling businesses.
Any SME that has under-recovered or over-accounted for VAT in the past four years can address this by making a claim to HMRC. The reverse is also true and HMRC have the right to assess for any underpayments in the same timescales.
I would always advise any registered company to carry out regular reviews of their treatment of income and VAT recovery position, as doing this could reduce the risk of penalties which tend to be significantly higher if HMRC uncovers a discrepancy. That could result in what is often the worst kind of headache for an SME: a financial one.