VAT for your small business

First published 08 October 2019 • Updated 08 October 2019

VAT for small businesses

VAT is one of the most important areas of business tax to get right. Not only can it be a big challenge in terms of accounting, but it can also affect your competitiveness and your profit margins. Handling VAT effectively is therefore a fundamental part of running any successful small business – it’s not just about keeping HMRC happy.

What is VAT?

The standard rate of VAT is 20 per cent, though there are other rates on some products and services.

VAT (Value added tax) is a tax on most goods and services, levied at the point of sale. This increases the retail price of anything that is ‘VAT-able’.

As a business, most goods and services that you buy from suppliers will have VAT added to the price. You may also have to charge VAT to your own customers. Managing VAT is therefore a bit of a juggling act: working out how much VAT customers pay you, how much you pay to suppliers, and thus how much you need to pay to (or reclaim from) HMRC.

Should I register my business for VAT?

You can only reclaim VAT if you are VAT registered – and if you are, you must also charge it. If your business turns over more than £85,000 of VAT-able goods or services (i.e. those not exempt or zero-rated) then you must register. If you turn over less than this, then you can still choose to register for VAT. There are upsides and downsides to doing this, so you will need to weigh these up to see which option is best for your business.

The advantages of being VAT registered

Registering your small business for VAT even if it’s below the £85,000 turnover threshold can have several benefits.

Firstly, if you buy a lot from suppliers who charge VAT, you can claim this money back against the VAT that your own business charges. For example, if you buy £10,000 of VAT-able stock and services from your suppliers, you’ll pay £12,000 in total – £2,000 of which is VAT. If you then make VAT-able sales of £12,000 to your customers, £2,000 of this will also be VAT. In this example, your net VAT bill would be zero.

Of course, you’d hope to make more in sales than you spend on suppliers, so your VAT bill should be a positive figure – but being able to reclaim VAT may still lower your overall costs.

The second potential advantage of being VAT registered is that other businesses may prefer doing business with you, as it gives the impression of being larger and more established even if you’re just starting out.

The disadvantages of being VAT registered

There may be a few drawbacks to being VAT registered if your taxable turnover is under £85,000. The most obvious one is that you’ll have to charge VAT on your taxable products or services – which will either make them more expensive or reduce your margins (or a little bit of both). A small business whose main selling point is low prices may therefore benefit by not being VAT registered (though you would still have to pay it when buying VAT-able stock).

The other downside to being VAT registered is the administrative burden. You will have to submit quarterly VAT returns, and to ensure these are accurate you will probably need an accountant.

What are the different VAT rates and what do they mean?

The standard rate of VAT is 20 per cent, but some products and services have a lower rate of VAT, a zero rate, or are fully exempt.

VAT rate

Tax

Applies to

Standard

20%

Most goods and services

Reduced

5%

Selected goods and services, such as nicotine patches, energy-efficient materials for homes, central heating servicing and repair

Zero

0%

Selected goods and services, such as most food, children’s clothes, dispensing of prescriptions

Exempt

n/a

Selected goods and services, such as gambling, online gaming, funerals, sport & leisure activities, financial services.

What is the difference between zero-rated and exempt from VAT?

You may wonder how a product zero-rated for VAT differs from an exempt product. The difference lies in whether or not your business can register for VAT and reclaim it. If a business only sells products or services that are exempt from VAT, then it cannot register for VAT (and so can’t reclaim the VAT charged by its own suppliers).

However, if your business sells zero-rated products or services, then you can still register for VAT and reclaim any VAT charged by your suppliers – even though you won't charge any VAT to your own customers.

If your business offers a mix of goods/services, some of which are zero-rated and some of which are exempt, VAT accounting for these can get quite tricky. Your accountant will have to establish how much VAT you can reclaim on goods/services bought from your suppliers, based on the extent to which these goods/services help deliver your own VAT-able products. For example, you couldn’t reclaim VAT on sporting goods that enabled you to deliver a sports class, as the sports class would be VAT-exempt.

Some businesses may offer a wide range of products that are standard rate, reduced rate, zero rated and exempt from VAT. All will need to be carefully accounted for so that the right amount of VAT is reclaimed.

How to register for VAT

You can register for VAT online at the government’s website. Remember that you must do this if your VAT taxable turnover is over £85,000.

Once registered you’ll receive a VAT registration certificate, confirming your VAT number and when your first VAT return and payment are due.

How long does it take to register for VAT?

Once you've submitted your application, you can expect to receive your certificate in around one month. However, you must start accounting for VAT on the date that you submit your application, so keep careful records during this month (and from then on!).

Can I reclaim VAT on purchases made before I registered?

You can make backdated VAT claims on products or services you bought before registering for VAT. You can reclaim VAT from up to four years before the date of your registration, provided it was paid on goods you still own or that were used to make goods you still own.

For services there is a shorter deadline, as you can only reclaim VAT for services bought up to six months before the date of your registration.

All such goods or services must be for the purposes of the business that you have registered for VAT. It is best to reclaim them on your first VAT return, and ensure you still have all relevant invoices and receipts, along with information as to how these purchases relate to your business.

Do I need an accountant to handle my VAT?

Unless your business is very small, VAT accounting can become burdensome very quickly. In particular if you are over the £85,000 taxable turnover threshold, you will want to ensure that your VAT returns are as accurate and efficient as possible. At best, mistakes can reduce your operation margins, and at worst they can trigger an investigation from HMRC. An accountant can ensure that the whole process goes smoothly.

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About the author
Nick Green
Nick Green
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.