Ahh, VAT – most people have heard of it but not many understand it, and we know that it’s confusing for many self-employed, contractors and small business owners.

Although the ins and outs may be tricky to grasp for first-timers, the sooner you get your head around HMRC’s VAT rules, the better it’ll be for your business.

First things first – what is VAT?

VAT – or Value Added Tax – is a tax charged on most goods and services in the UK and the EU. When you buy a product that is eligible for VAT in a shop, for example, VAT is automatically included in the price you pay.

There are three rates of VAT which are applied to goods and services in the UK. Standard Rate (currently 20%), Reduced Rate (currently 5%) and Zero Rate (0%). Items may also be exempt (or ‘outside the scope’) of VAT. 

In recent years the UK government has introduced temporary measures to reduce the rate of VAT paid in certain business sectors, such as hospitality. So it’s important to understand the rate of VAT applicable to your business and the purchases it makes.

“Aren’t Zero Rated VAT and VAT exempt the same thing?”, you may be asking. Well, no. Zero-rated means that the goods are still VAT-taxable but you don’t charge your customers any VAT. You still have to record these sales in your VAT accounts and report them on your VAT Return, which means you can reclaim VAT on your expenses.

VAT exempt items are outside of all VAT schemes and are not taxable. You don’t include sales of exempt goods or services in your taxable turnover for VAT purposes. If you buy exempt items, there’s no VAT to reclaim.

In both cases, you don’t add VAT to the selling price, but zero-rated goods or services are taxable for VAT – albeit at 0%.

Sales of zero-rated items count as ‘taxable sales’ as far as the VAT registration threshold is concerned, along with sales that are subject to 5% or 20% VAT.

Examples of goods and services and their VAT rates

Here are some examples of goods and services and their VAT rates:

‍*1 As part of the government’s economic measures to respond to the COVID-19 emergency, VAT in the hospitality and tourism sector was reduced from 20% to 5% until September 2021.

*2 Since 1st December 2020, no VAT is payable on e-books and online newspapers, magazines and journals.

Since leaving the EU, there have been many changes to what items are subject to VAT rates. For example, previously sanitary products were subject to the reduced rate of 5%, however in 2021 this "tampon tax" was abolished with effect from January 2021.

Who can register for VAT?

There’s a common misconception that only people operating their own limited company can register for VAT, when actually VAT registration is open to sole traders as well. Regardless of your business structure you can choose to voluntarily register whenever you like, but there comes a point when legally you must register.

{{ltd-guide}}

When must I register for VAT?

Legally, you must register for VAT when:

• Your VAT-taxable turnover (the total of all sales that aren’t exempt from VAT) exceeds the current threshold of £90,000 within a 12-month period (on a rolling basis)
• You expect your VAT-taxable turnover to exceed the threshold in a single 30-day period
• You only sell goods or services that are exempt from VAT, but you purchase goods to use in your business to the value of more than the threshold from VAT-registered suppliers in the EU.

You need to register for VAT within 30 days of meeting any of these criteria.

If you know your turnover will reach the threshold soon, you should allow enough time to register. If you fail to notify HMRC in time, you may be liable to pay a penalty!

There are some situations in which it may be beneficial to voluntarily register for VAT before you reach the threshold(see below). 

If you are using the VAT MOSS scheme you may need to register for VAT in the UK. Read our article for more detail on VAT MOSS.

When should I start charging VAT?

When your turnover reaches the VAT threshold in a rolling 12 month period, you must start charging VAT from the first day of the second month after you exceed the threshold.

For example, if on 30th June 2024, your sales for the previous 12 months are £90,000, then your VAT registration date will be 1st August 2024.

When you expect to exceed the threshold in a single 30-day period, you need to start charging VAT immediately.

Why is VAT charged on top of recharged expenses?

Recharges are costs that your business incurs when supplying goods and services which you pass on to your customers. If you’re VAT registered, you’ll need to charge VAT on the amount recharged to the client, even if the expenses your business initially incurred and paid for are not subject to VAT.

A good example is a train ticket, which is not subject to VAT rules. If you pay £100 for your ticket, you include that amount as an expense in your company accounts. However, if you pass the cost on to your client and include it on a sales invoice, you need to add VAT. This situation is quite different to your client reimbursing expenses at cost.

There’s no requirement for you to charge the client the same amount you paid in expenses. So using the above example, if you decided to charge your client £150, you’d need to add VAT to that amount.

What happens if I don’t register for VAT when I should?

If you’re late in registering, HMRC will retrospectively register your business from the date you should have started charging VAT. 

You’ll need to add VAT to all sales made from this retrospective date, regardless of whether you actually charge your clients VAT, so you could well lose out if you don’t register when you should. HMRC may also issue you with a financial penalty.

So again, if you know your turnover is approaching the threshold soon, allow enough time to register.

There are some situations in which it may be beneficial to register voluntarily before you reach the threshold.

Why would I consider voluntary VAT registration?

There are a number of reasons why it might be worth voluntarily registering for VAT even if your turnover is not above the VAT threshold. These include:

• You can reclaim the VAT on your business expenses (if you are on the Standard Rate scheme)
• You can register for a reduced Flat Rate of VAT to reduce the administration involved in preparing your quarterly VAT return (Flat Rate scheme)
• If your clients are large companies who are themselves VAT registered, registering could be advantageous. Your clients will be used to seeing prices inclusive of VAT, and will be able to reclaim the VAT paid over to your business
• It may make your business more credible in the eyes of your clients, in the same way that having a limited company makes you appear more ‘professional’.

You should speak to an accountant for individual advice on your situation.

Why might I not want to register voluntarily?

• If your clients are smaller companies and not VAT registered themselves, the addition of VAT may make you seem more expensive. Registering for VAT usually requires you to add 20% to your invoices, and if your client isn’t VAT registered, they can’t reclaim this

• With VAT registration comes additional responsibility. You’re required to complete and file a VAT return, usually every three months. If a return is late, there will be a penalty from HMRC
• Since 1st April 2019, if you're above the VAT threshold, you need to comply with Making Tax Digital for Business rules, which means keeping electronic records and submitting digitally using approved software such as Crunch. *(All VAT registered businesses are now Making Tax Digital for VAT)

• When you’re VAT registered, it can be more difficult to keep track of your cash flow and profit. However, as a Crunch client, we’ll calculate your VAT liabilities automatically, so you’ll always have an up-to-date picture of your accounts.

{{cta-limited-company}}

How do I register for VAT

Registering for VAT is usually done online - Gov.uk has all the information you need for how to do it, or if you use online accounting software like Crunch, then we’ll take care of all the registration for you as well as all your filing and calculations. Firstly you need to decide whether you should register for Standard Rate VAT or Flat Rate VAT.

Standard Rate VAT vs Flat Rate VAT schemes

When you register for VAT, you have two choices of schemes. The first, Standard Rate VAT, involves reclaiming VAT on every eligible item you buy or sell. 

The second, Flat Rate VAT, is open to businesses with an expected turnover of less than £150,000 (in the next 12 months) and was introduced to simplify the VAT system for freelancers, contractors, and small businesses.

On the Flat Rate VAT scheme, you’ll use a predetermined VAT rate based on your industry type and pay this over to HMRC. 

First, you add the Standard VAT rate of 20% to your sales invoice amount, then you collect the full amount from your client. 

Next, apply your sector percentage to this (gross) amount, which is then paid over to HMRC via a VAT return. The difference between the two rates is retained by your business (limited company) as income.

There’s a range of VAT rates for specific industry types available below. We’ve also got an article explaining the Limited Cost Trader Test that is used by many “labour-only businesses” such as contractors.

When you register for the Flat Rate scheme for the first time, HMRC allows you to apply for a 1% discount in the first year.

*‘Labour-only building or construction services’ means building services where the value of the materials supplied is less than 10% of the turnover for those services. If more than this amount, the business is classed as ‘General building or construction services’.

How do I know which VAT scheme is best for me?

Generally, when deciding whether to register and on what scheme, you need to look at your turnover, the type of clients you have, and the expenses you incur that you can claim VAT on.

The table below is a guide to which scheme may be more appropriate for you. It’s important to remember that this should only be used as a guide, nothing beats getting direct support from one of our expert accountants to discover what’s best for you and your business.

Example using the 14.5% Flat Rate

Your business charges £1,000 to a client for services your company provides. The client will pay £1,200 including the Standard Rate of VAT amount at 20% (£200). Your business pays HMRC the industry Flat Rate of VAT amount at 14.5% of £1,200 which is £174. The business accounts for the difference (£26) as income.

You can’t reclaim the VAT paid on your purchases under the Flat Rate scheme - except for certain capital assets over £2,000. When you register for the Flat Rate scheme for the first time, HMRC allows you to apply for a 1% discount in the first year.

You can see a full list of VAT sectors and their associated rates in our tax rates and thresholds article.

How often do I need to file a VAT return?

You can choose to file VAT monthly, quarterly (common with most Crunch clients) or annually. If you don’t file a return when it’s due, you’ll incur a penalty from HMRC.

If you’re a Crunch client, our software automatically generates your VAT return. You’ll be notified when a return is ready. Simply let us know you’re happy with it and we’ll file on your behalf.

If you’re not a Crunch client then you’ll need to use HMRC approved software to file your VAT return since the government’s MTD for VAT scheme came into force on 1st April 2019.

How do I report VAT and file a VAT return?

For registered business, a VAT return is required (usually every quarter) to tell HMRC how much VAT you have paid and received. 

All VAT returns are filed online, and can usually be handled by your accounting software. Depending on your income and expenses, you may need to make a VAT payment to HMRC or you may be owed a refund.

A new point system for late filing has been introduced effective from the 1st of January 2023, with each late submission resulting in a point. There will be a fixed £200 penalty when the points threshold is exceeded. HMRC will not be charging for late penalties for the first year between the 1st of January 2023 to the 31st of December 2023.

The points threshold is dependent on how you file your return. See the thresholds below:

Your points will reset back to zero if you meet both of the following conditions:

• submit returns on or before the due date for period of compliance (based on submission frequency)
• file all outstanding returns due for the previous 24 months 

What is VAT MOSS?

VAT MOSS (short for Value Added Tax: Mini One Stop Shop) is a way of paying VAT for businesses supplying digital services directly to customers in EU countries.

VAT MOSS covers businesses supplying digital services to customers (known as ‘B2C’). The services include broadcasting, telecoms and e-services. The rules apply to sole traders and limited companies.

If you supply digital services to businesses (known as ‘B2B’) then VAT MOSS doesn’t apply.

Read our article for more information on how VAT MOSS is affected by Brexit.

What should I do next?

If you’re close to the VAT threshold (or think you may be), then your accountant should be able to advise you on whether you should consider registering and what scheme would be best for you.

If you don’t yet have an accountant or are thinking of switching, then why not speak to Crunch? Our combination of online accounting software and unlimited access to dedicated client managers and expert accountants could be just right for you. 

Find out more about how we can help you and your business.