Value Added Tax is a tax that VAT-registered businesses charge when supplying goods or services in the UK, the Isle of Man, and on some sales to the EC. This guide outlines what is involved. Note that all financial thresholds are excluded from this guide because they change regularly – contact Customs & Excise (C&E) for these.

In essence, if you are VAT registered, you add VAT to all your invoices. At the end of the period, you pay the Customs & Excise (C&E) the total you have charged (output tax) less the total VAT you have paid your suppliers (input tax).

There are three rates of VAT in the UK:

• Zero-rated supplies such as food (not including take-away food and drink, eating establishments), children’s clothes and books.
• 5%, such as on supplies of fuel and power for domestic and charity use.
• Standard rate, currently 17.5%, which is the most commonly charged rate on the majority of goods and services.

However, some items are exempt from VAT, including certain financial services, domestic rent, funeral services and education.

Who should register?

All businesses with a turnover that goes above a certain threshold must register for VAT purposes. Businesses below this turnover threshold need not register, but there may be advantages in doing so.

• Individuals, not businesses, are registered for VAT purposes. Each registration covers all the business activities of the registered person. This means you cannot hive off parts of your business so that you fall outside the VAT threshold. Partnerships are regarded as a single entity for VAT purposes. It is unwise for a husband and wife to maintain that they are trading separately without C&E’s agreement in writing. Limited companies and charities are also regarded as individual entities.
• You need to notify C&E when your taxable turnover for the past 12 months (any 12 months, not necessarily just your tax year) exceeds the threshold. Notification must be within 30 days of this.
• If you are starting a new business and you expect to exceed the turnover threshold immediately, you must notify C&E at once.
• If you buy a VAT-registered business and its turnover has previously exceeded the turnover threshold, you must notify C&E at once. You can take over an existing VAT number, but there are drawbacks to this.
• You must also notify C&E if you acquire more than a certain amount of goods or services from VAT-registered traders in other EU countries in any 12 months.
• You cannot backdate your registration more than three years from the current date. This means that if you started in business within this time, you can still reclaim the VAT on goods purchased. You would, however, have to account for VAT on any sales made during the same period. This is likely to be very costly for you, as you will have already invoiced most of the sales without charging VAT.

Voluntary registration

Even if your turnover is below the registration threshold, it may pay to register for several reasons:

• It can enhance your credibility if you sell to big businesses.
• It can help prove to the Inland Revenue that you are genuinely self-employed.
• If your sales are zero-rated, you can still reclaim VAT on your business purchases.
• If all your customers are registered themselves, you can recover VAT on your costs without your customers suffering the VAT on your charges, as it becomes part of their input tax which they can reclaim against their output tax.

You can also register before making any sales at all, providing you satisfy C&E that there is a genuine intent to trade. This is becoming increasingly hard to do, however, and you may have to go to some lengths to provide evidence.

How to register

Get the relevant forms from your Regional Registration Centre. C&E will check your forms, then send you a certificate of registration. You must put your VAT registration number on every sales invoice and charge VAT on all taxable goods and services.

Charging VAT

You must charge VAT on all goods and services that you supply unless these are exempt or zero-rated. This includes charging VAT on postage and packing where it is charged as a separate item, and charging VAT on normally zero-rated items such as rail fares, where you are invoicing a customer for your travelling expenses connected to a VATable sale.

This guide refers to charging VAT, but the VAT system does not give you a clear right to add VAT to your price; that is a point to cover in your contract terms and conditions.

Reclaiming VAT

You can reclaim VAT on supplies that are wholly and exclusively related to the business, and where you have a VAT invoice – so always ask for, and keep, receipts, and make sure they have the supplier’s VAT number on them.
You cannot reclaim VAT on:

• Privately used goods or services. However, where only some of the use is private – for example, telephone calls from your mobile – you can claim the appropriate proportion of business usage.
• Entertaining customers.
• ertain capital items such as some vehicles. However, if you lease a company car, you can recover 50% of VAT paid on the lease payments.
• Most petrol or diesel for cars unless you pay C&E a fuel scale charge. You can reclaim the VAT element of mileage allowances paid to employees.

Although you cannot reclaim VAT on supplies that are not made direct to you, there are some circumstances when the rules are relaxed. These include subsistence expenses repaid to employees where the invoices are made out in the name of the employee, rather than the business.

How long must you keep records?

Keep VAT records for six years – C&E can ask to see any item at any time.

Your accounting records must include items such as a VAT account – ie VAT that you have charged and paid for in each period that is covered by your VAT returns, including all zero, reduced and exempt rate supplies.

Any adjustments also need to be recorded, such as changes to your accounts or credits.

Your books must be up to date, and if C&E feels that these have not been kept in a way that provides enough information, then they can demand changes.

Second-hand goods and antiques

The VAT position on most second-hand goods is covered under a special scheme whereby, rather than account for VAT on the full selling price, you pay tax on the difference between the price that you pay as a buyer, and the price at which you sell.

This ‘Margin Scheme’ is very comprehensive, and can apply to works of art, antiques and collectors’ items. Before applying this, check your eligibility, as it is a complex system.

There are also other schemes that may apply – subject to the type of goods being supplied.

Imports and exports

Sales to other EU countries

Goods – these transactions are not subject to UK VAT, provided that they relate to the customer’s business. To ensure this, you must put the customer’s VAT number in their own country on your invoice. If the supply is for private use, charge VAT in the normal way.

Services – this is a very complex area. The VAT treatment of the supply depends upon the type of service, where it is supplied and where the customer is based. If you are in any doubt, seek advice.

Sales outside of the EU

Goods – these supplies will be zero-rated but only if you obtain and keep proper evidence of export in the form of shipping or airway bills.

Services – the VAT treatment will rely on the types of service being provided and where it is performed. Again, seek advice.

Purchases from other EU countries

Goods and services – you should not be charged VAT providing that you give your supplier your UK VAT number. If the services are not zero-rated or exempt from VAT in the UK, you should calculate a nominal amount of UK VAT on the purchase value and enter this on your VAT return as both output and input tax.

Purchases from outside of the EU

Goods – duty and VAT will be payable at the port of importation prior to release of the goods. The VAT can only be recovered using a form C79.

Services – if the services are not zero-rated or exempt from VAT in the UK, you should calculate a nominal amount of UK VAT on the purchase value and enter this on your VAT return as both output tax and input tax.

Selling off the web

By its very nature, it is often impossible to know where a visitor to an Internet website is actually located. Yet whether VAT is chargeable or not on anything depends on whether the recipient is in the UK, the EU or elsewhere.
For any goods or services that are actually delivered (downloaded) off the web, it is probably wisest to charge VAT on everything, unless the recipient can prove they qualify for relief.

Without such evidence, C&E could come along later and ask for the VAT due on all web sales backdated as appropriate. If you didn’t collect any, you would have to find it out of profits, which could be disastrous.

Selling material over the Internet has changed some previously ‘zero-rated’ categories to taxable categories. For example, you might sell zero-rated newsletters or guides and deliver them by mail. However, if you now deliver them electronically over the Internet, you may have to charge VAT at 17.5%. Double-check your situation with C&E if you sell products over the internet that are normally zero-rated.

Property transactions

The VAT rules applying to property are very complex and, because of the sums involved, mistakes can be very expensive. So in order to address the VAT situation correctly, seek expert advice before buying, selling or leasing land or buildings.

Three main ways to account for VAT

Quarterly accounting

You account for VAT quarterly on the invoices issued and received in the period. You pay for all VAT due, whether or not your clients have paid your invoices that incurred it.

Usually VAT bad debt relief is not available until the debt is six months old. However, under the cash accounting system explained below, the problem of VAT on bad debts disappears.

Cash accounting

Registered traders whose turnover is not expected to exceed a particular threshold in the following 12 months may use this scheme. This allows you to account for VAT based on the actual payments received, instead of on the invoices issued and received.

You can start using this scheme at the beginning of a tax period – you do not need permission to use it.

Cash accounting can improve your cashflow if customers normally take a long time to pay. If, however, your customers pay promptly, you would probably be worse off because of the loss of input tax on unpaid creditors under cash accounting.

VAT cannot be accounted for again on receipts and payments of invoices issued and dealt with before you started to use the scheme.

You may not use cash accounting for the sale of goods or services invoiced in advance of the supply being made, or where payment for sales is not due for more than six months after the invoice date.

You must apply the scheme to the whole of your business. However, if you find your accounts system is unable to comply with the requirements, or if it proves to be of no benefit, you may leave the scheme.

Once your turnover exceeds the threshold, you are usually able to continue in the scheme until you reach the 25% tolerance limit. You must account for all outstanding tax in the period in which you leave the scheme.

When should you account for payments?

• With credit card payments – the date on the sales voucher is the one that applies rather than the date you receive payment, or make payment to the credit card company.
• With cheques, the later of either the date on the cheque, or the date that it is sent to a supplier applies.

You should be careful, though, if you leave the cash accounting system. This will have a big effect on your cashflow, since you will have to pay over the VAT on your receipts from the old cash accounting scheme, as well as on the invoices of the new accruals scheme, at the same time.

Also, if you have a cyclical business, you need to watch out that you don’t have a large VAT bill to pay from the receipts of the previous quarter, just when business has gone quiet.

Annual accounting

Here, regular payments are made on account as agreed, and you complete only one VAT return a year, thus reducing the administration and helping a business’s cash flow.

The benefits of this scheme include:

• Payments are spread.
• Easier cash flow forecasting.
• An extra month is given for submission of the VAT return, and only one needs to be completed a year.

Payments on account must be made monthly, quarterly or annually, depending on your overall VAT liability.

If turnover exceeds the scheme threshold then, as with cash accounting, there is a tolerance of 25% so the scheme can be used until the end of the year in which your taxable supplies exceed this level.

There are some disadvantages to the scheme, however. For example, there may be an adverse effect on cashflow caused by variations and interim payments based on earlier years, which may be higher than necessary. You can reduce interim payments but only if there is a significant difference.

Payments must be made by a direct method, such as direct debit.

Unexpected changes in turnover and trading may be taken into account and interim payments adjusted. Any VAT balance at the end of the year must be paid two months after the year-end, when you submit your VAT return.

Flat Rate Scheme

An alternative simplified scheme is available for low-turnover traders, who can account for VAT on a fixed percentage on their total sales. The percentage will depend on what trade you are in. It is not advantageous in some cases, so a careful review of the likely impact should be made.

Penalties

There are various penalties for late payment, late registration, errors, and not submitting a VAT return on time. These include:

• A fixed penalty of £500 if you do not keep records for six years.
• A flat rate penalty of £5000 for non-disclosure of a VAT avoidance scheme.
• An escalating level of default surcharge if C&E does not receive your return and all VAT owed by the due date.
• Default interest charged on VAT errors made on VAT returns.
• Misdeclaration penalties imposed on large errors made on VAT returns.

HM Customs & Excise
T: 0845 010 9000
W: www.hmce.gov.uk

VAT inspections

C&E has the right of access to premises and records at any time. Your records must be up to date and easily understood.

C&E officers may visit to look at records to make sure that you are paying the right amount of tax and duty, and that you are complying with all of the requirements. However, if they can resolve an issue by phone or letter, they will.

The frequency of visits depends on the size and complexity of your business, but expect an inspection every three years or so. The visit itself may take a couple of hours or a few days, again depending on your business.

C&E will normally tell you what it will need to see, and for what accounting period, before visiting, and arrange a time that is mutually convenient. You can request a written report after the visit, and if you disagree with any of the decisions, you should put it in writing, clearly stating your case.

The best person to represent you during a visit is someone who knows your accounting systems – the more helpful information you can provide, the shorter and less stressful the visit. You may want your accountant present to deal with any problems that may arise.

VAT is complex, and the amounts involved over a period of six years can be large so, if you are in doubt, seek clarification from your local C&E office or an accountant.

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