Value-added tax (VAT) is a consumption tax applied to goods and services at each stage where value is added, from production to distribution. More than 170 countries use VAT, including the United Kingdom. Unlike a sales tax, which is collected only at the final sale to the end customer, VAT is collected throughout the supply chain.

VAT can feel overwhelming for small business owners in the UK. Whether you’re launching a startup or managing a growing enterprise, understanding VAT – what it is, how it works, and what it means for your business—is important.

What’s in this article?

• How does VAT impact small businesses?
  
• What are the different VAT schemes available?
  
• How to register for VAT: A step-by-step guide
  
• How to prepare and submit your VAT return
  
• How to handle VAT inspections and audits
  

How does VAT impact small businesses?

For small businesses, VAT can impact various aspects from cash flow and pricing to day-to-day operations. Here’s how VAT affects businesses:

• Businesses must charge VAT on their sales invoices and then pay it to the government, sometimes before receiving payment from the customer. Small businesses with tight margins or long payment terms might need to plan to cover a gap in cash flow.

• Businesses must keep detailed records of all sales and purchases, file regular VAT returns, and stay informed of any changes in tax rules. This can be a lot to handle for a small team, and some businesses need to use accounting software or outside help to manage everything.

• Small businesses with annual taxable turnovers below a certain threshold can choose whether or not to register for VAT. This can impact pricing strategy and overall financials. Adding VAT to prices can make goods or services more expensive for customers and negatively affect sales. But VAT-registered businesses can reclaim VAT on business expenses, which can help balance some costs.

What are the different VAT schemes available?

There are several VAT schemes available that can help small businesses manage their VAT obligations more effectively, depending on their size and business type. Here’s a breakdown of the most common VAT schemes:

• Standard VAT: This is the default for most businesses. They pay VAT on their sales and reclaim VAT on their purchases based on the invoice date, regardless of whether they’ve been paid or paid their suppliers.

• Flat Rate Scheme: This is designed for small businesses with a turnover of up to £150,000. Instead of calculating VAT on every transaction, they pay a fixed percentage of their gross turnover; the VAT amount varies by industry. While companies can’t reclaim VAT on purchases (except for certain capital assets), this scheme simplifies the process and reduces paperwork.

• Cash Accounting Scheme: With the Cash Accounting Scheme, businesses pay VAT only when they receive payment from their customers and reclaim VAT when they pay their suppliers. This helps avoid the issue of paying VAT before receiving payment and makes it easier to manage cash flow.

• Annual Accounting Scheme: With the Annual Accounting Scheme, businesses submit just one VAT return per year, instead of every quarter. They make one advance payment based on their estimated annual VAT liability, and any differences are adjusted at the end of the year. This scheme can help businesses with budgeting and planning but might not suit those with fluctuating turnovers.

• Margin scheme: Under a margin scheme, VAT is calculated on the difference between the purchase price and the selling price (the margin) rather than on the full selling price. This can reduce the VAT payable substantially but requires strict recordkeeping.

• Retail schemes: Retail schemes simplify the VAT calculation process. There are several types of retail schemes, including the Point of Sale Scheme, Apportionment Scheme, and Direct Calculation Scheme. Each is designed to suit different types of retail businesses. These schemes allow companies to calculate VAT once rather than track VAT for each individual sale.

How to register for VAT: A step-by-step guide

Here’s how to register for VAT.

Check if you need to register

First, determine if you need to register for VAT. In the UK, registration is mandatory if your business’s taxable turnover over the past 12 months exceeds £90,000 or is expected to exceed it in the next 30 days. If most of your taxable goods or services have a VAT rate of 0%, you might be exempt from registering. Even if your turnover is below the threshold, you can choose to register voluntarily. This might benefit you if you work with other VAT-registered businesses.

Gather necessary information

Before you begin the registration process, collect all your business details in one place. The required information can differ depending on your business structure (e.g., sole trader, partnership, limited company), but you’ll need the following for any business structure:

• Bank account details

• Your annual turnover

• Your Unique Taxpayer Reference (UTR) or National Insurance number

• Your Self Assessment return

Choose the right VAT scheme

Decide which VAT scheme best suits your business. Options include the Flat Rate Scheme, Cash Accounting Scheme, and Annual Accounting Scheme. The right scheme will depend on your business type, size, and cash flow needs. Research each option so you can choose the one that is most beneficial for you.

Register online

The UK offers an online VAT registration process through the government’s tax portal. Log on or create an account if you don’t already have one. Complete the online VAT registration form by providing the required business and financial details.

Submit your application

Once you’ve filled in all the necessary information, review your completed application carefully for accuracy before submitting. You should receive a confirmation email that your application has been submitted.

Receive your VAT registration certificate

After your application is processed, you’ll receive a VAT registration certificate within 30 working days. The certificate will confirm your VAT registration number, registration date, and provide details on when to submit your first VAT return.

Implement VAT invoicing and record-keeping

Once your business is registered, you must include your VAT number on all invoices and keep detailed records of all sales and purchases, including the VAT charged and paid. You must also keep proper records to file accurate VAT returns and avoid penalties. Your records should include:

• All sales and income (including the VAT charged)

• All purchases and expenses (including the VAT paid)

• VAT on any goods imported or exported

• Any adjustments, discounts, or refunds

To simplify this process, consider using accounting software that supports VAT compliance.

File your first VAT return and make payments

After registration, you’ll need to start filing regular VAT returns (typically on a quarterly basis) and making VAT payments to the government. Submit these returns and payments on time to avoid fines and interest charges. Take note of the deadlines that your VAT registration certificate provides.

How to prepare and submit your VAT return

After you’re registered, it’s time to prepare and submit a VAT return. Here’s how to do so.

Calculate your VAT liability

The VAT return shows the amount of VAT you owe the tax authority (output VAT) minus the VAT you can reclaim on your business expenses (input VAT). The difference is your VAT liability. If your output VAT exceeds your input VAT, you’ll need to pay the difference to the tax authority. If your input VAT is higher, you might receive a refund.

Complete your VAT return form

Log on to the online portal of His Majesty’s Revenue & Customs (HMRC) to access your UK VAT return form. The form typically requires that you provide the following information:

• Total sales and purchases (excluding VAT)

• Output VAT (the VAT you’ve charged on sales)

• Input VAT (the VAT you’ve paid on purchases)

• Any VAT adjustments or corrections

Follow the prompts on the form and fill in each section carefully. Assure that your figures match the records you’ve kept over the VAT period.

Check for errors

Double-check your VAT return for common mistakes such as transposed numbers, incorrect calculations, and missing information. Ensure you’re using the correct VAT rates and that all figures are accurate. Errors can lead to penalties or delays in processing your return.

Submit your VAT return online

Once you’ve completed and reviewed your VAT return, submit it online through the HMRC portal. After submission, you’ll receive confirmation that your VAT return has been successfully filed. Keep this notice for your records.

Pay any VAT due

If you owe VAT, pay the amount by the due date. Most tax authorities provide several payment options such as direct debit, bank transfer, and credit card. Late payments can result in interest charges and penalties. If you are owed a refund, it will usually be automatically processed once your return is reviewed.

How to handle VAT inspections and audits

If you’re well prepared, handling VAT inspections and audits is a simple process. Here’s how to manage them:

• Stay organised and compliant: Keep thorough, accurate records of all sales, purchases, VAT returns, invoices, and receipts. Ensure that your VAT filings are accurate and submitted on time. Use accounting software if necessary to maintain organised, accessible records.

• Understand the scope of the audit: When notified of an upcoming VAT inspection or audit, find out what the tax authority intends to review. This could include specific periods, transaction types, or VAT reclamation practices. Gather the relevant documents and prepare accordingly.

• Review your records in advance: Before the audit, conduct an internal review of your VAT records to ensure everything is in order. Look for any discrepancies or errors that might need correcting. If you spot any issues, address them promptly and be ready to explain any anomalies.

• Cooperate and communicate clearly: During the audit, provide the requested information and documents promptly. Be transparent and clear in your communications. Respond to any requests for clarification or additional information.

• Seek professional help if needed: If you’re unsure about any aspect of your VAT records or the audit process, consider consulting a tax adviser or accountant. They can help you prepare, provide expert guidance during the inspection, and assist in communicating with tax authorities.

• Address findings promptly: After the audit, the tax authority might provide feedback or findings, including any required adjustments or penalties. Address any issues promptly to avoid further complications, and implement any recommended changes to improve future VAT compliance.