A Guide to VAT for Start-up Businesses
A step by-step guide to Value Added Tax (VAT) and when you need to register your business for it
Value Added Tax (VAT) is a tax on business transactions of goods and services, and if you are a business owner, it is likely to apply to you at some point.
Once the turnover of your business reaches the VAT threshold, £81,000, you must register for VAT – and you have to account for VAT whenever you supply goods and services.
You shouldn’t put off VAT registration as this can incur severe penalties and can be expensive as you will have to pay HM Revenue & Customs (HMRC) the tax you should have collected, as well as a possible fine.
Below, we have put together answers to the most common questions business owners ask about VAT – this article should provide you with a good introduction to what is often a confusing area of tax law. If you need further information, visit the HMRC website or call the body’s VAT Helpline on 0300 200 3700.
How does VAT work?
VAT is charged at 20% on most supplies, though some items are taxed at exempt, zero-rated or reduce-rated at 5%. We cover this in more detail below. If you sell customers VAT taxable supplies, the tax charged on those supplies is called ‘output tax’. Most businesses simply factor in VAT into the final purchase price, passing the cost on to the customer.
In the same way, the VAT you pay suppliers for your business supplies is called ‘input tax’. This includes raw materials, goods you buy to re-sell, business equipment, business phone calls and payments for professional services. If you are using these supplies for your business, you can generally reclaim the input tax you paid at a later date. As a business, you will pay HMRC the excess of the output tax you have made over the amount you can reclaim as input tax at regular intervals. So, if you have sold goods with £30,000 worth of VAT and paid £15,000 VAT on business equipment you brought in over the same period, you would pay HMRC £15,000 for the period.
Most businesses usually collect more output tax than input tax and this tax surplus has to be paid to HMRC in a quarterly VAT return. You can find the relevant forms for VAT returns here.
What are the different VAT rates and how they work?VAT is charged at different rates according to the goods and services supplied. It is split into four separate categories:
- Exempt supplies: This category includes finance, education, insurance and the services of dentists and doctors. VAT is not charged on exempt supplies and if you only supply exempt services you usually don’t need to register for VAT.
- Zero-rate: This is charged on most foods (not restaurants and take-aways), children’s clothing and shoes, construction of new houses, books, newspapers, and prescriptions. If you only supply zero-rated goods and services you don’t have to register for VAT but you do have to apply for exemption from VAT registration. Although you pay no VAT on zero-rated goods, it is not the same as an exempt supply.
- Reduced-rate: A rate of 5% charged on domestic fuel and power, residential conversions and certain refurbishments, as well as installing energy-saving materials in residential accommodation.
- Standard-rate: A rate of 20% which applies to all goods and services that do not apply to the other three categories.
When do I need to register for VAT?
Essentially, if your sales of VAT-rated goods over a 12-month period has exceeded, or is likely to exceed the current VAT turnover threshold of £81,000, your business needs to register for VAT.
You must notify the HMRC within 30 days of the end of the month in which sales in the last 12 months exceeded £81,000. You must also register with HMRC if your sales during the next 30 days alone are expected to exceed £81,000 – an example would be if you had secured a bumper new client with orders already in excess of £81,000.
How do I register for VAT?
To register for VAT, you need to contact your local HMRC office to start the process or complete the relevant VAT application forms online here.
It’s important to notify HMRC within the deadlines, as failing to do so can represent an expensive mistake. The regulator has the power to charge you as much as 15% of the VAT that would have been due on your first VAT return if you miss the deadline – and of course, you’ll still have to pay HMRC the original VAT you should have been charging customers.
Can I register for VAT if my turnover is below the limit?
Yes – and it can often make sound business sense, despite the additional paperwork and higher costs for customers it will incur. Even if your turnover is less than £81,000, being registered for VAT allows you to reclaim the VAT you paid on business purchases.
This is especially useful if you’re just setting up and want to make significant savings when getting set up with a large amount of new equipment. Bear in mind, though, you will need to provide evidence to HMRC that you eventually plan to sell VAT-rated products to customers; this option is not open to businesses in exempt sectors. Other situations in which you might want to consider registering for VAT:
- Your sales are zero-rated.
- Your customers are VAT-registered.