What is VAT and how does it affect my small business?

Published by Rupert Moyle on 21 February 2019

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Value Added Tax (VAT) is a tax chargeable on goods and services that are purchased or sold for use or consumption in the European Union (EU).

VAT is applicable in all EU member states. When sales are made to customers outside of the EU they are generally not subject to VAT, although there may be “sales taxes”, withholding tax or VAT equivalents in those countries which you may need to consider.

When do I have to register for VAT?

A UK business MUST register for VAT if:

  • Its ‘taxable’ turnover is more than £85,000 in any rolling 12 month period, which includes:
    o UK sales subject to a ‘rate’ of VAT;
    o the value of (most) services bought from anywhere abroad; and
    o the value of goods purchased from other EU countries; or
  • It expects its ‘taxable’ turnover in a single 30 day period will be over the £85,000 threshold

If you do not initially meet any of the above criteria then you do not have to register for VAT, but you could voluntarily register if beneficial to do so.

Why should I register for VAT if I don’t have to?

As a business in the UK you will be charged VAT by your suppliers. The standard VAT ‘rate’ in the UK is 20%, so VAT registered UK suppliers will ordinarily add 20% to their invoices.

If you are registered and charge VAT to your customers you can reclaim from HMRC the VAT on your purchases from suppliers. This means that VAT on expenditure is not usually a cost for a registered business.

If, however, you are not VAT registered (or your income is exempt from VAT) you cannot reclaim VAT charged to you, so effectively the cost of supplies in this instance would increase, usually by 20%.

Being VAT registered means that you need to charge VAT to your customers. So for standard rated sales to a UK customer you would either:

  • add 20% VAT to your invoices, e.g. £100 + £20 VAT; or
  • charge a VAT inclusive price, e.g. £120 inc VAT

If your customers are VAT registered then charging VAT should not be a problem for them; they should be able to claim back the VAT on their VAT returns. If your customers are not registered, however, such as if you supply private individuals or businesses that have exempt sales, then they will not be able to reclaim this VAT back and so effectively your goods or services will become 20% more expensive to them.

What do I need to think about?

When your business starts out, provided you have an intention to make ‘taxable’ sales, you need to consider whether you should VAT register from setup or not, taking into account the impact of:

  • how much VAT you will be charged by your suppliers and could reclaim if you were VAT registered;
  • who your customers are and what effect it would have on them if you registered and charged them VAT on your goods or services; and
  • how competitive this would make you compared with others in your market place.

It is worth noting that the rate of VAT is not always 20%. For example, food, children’s clothes and building new homes zero-rated sales (subject to VAT but at 0%). There is also a reduced rate of 5% for certain goods and services.

This means that you would have to consider these rates as well in regard to the VAT registration threshold, but also that despite not charging 20% VAT you could still be entitled to claim back VAT incurred on purchases.

And finally, a word of caution if your business involves international sales. If you sell your goods and services across the EU, particularly online, then there are other rules and regulations that you need to consider.

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