Explaining VAT – A Guide for Business Owners

Part 1 – What is VAT and Which Scheme is Right for Your Business?

What is VAT?

VAT stands for Value Added Tax and this year marks 50 years of VAT in the UK.  Quite simply, the purpose of VAT is to generate revenue for the government.  It is a widely used tax system in many countries around the world and plays a significant role in government revenue collection.

When a business is registered for VAT, it charges VAT on its sales (output tax) and collects it from the customer. The business can also reclaim the VAT it has paid on its purchases (input tax). The difference between the output tax and input tax is either paid to HMRC or refunded by them.

VAT is typically added as a percentage of the selling price of goods or services. The standard rate of VAT in the UK is currently 20%, but there are reduced rates of 5% and 0% for certain goods and services. Some goods and services may also be exempt from VAT altogether.

You must register for VAT if your total sales (turnover) is above the taxable threshold of £85,000 in a 12-month period and you must register if you know that you will exceed the threshold within 30 days.

In the UK, there are several VAT accounting schemes available for businesses. Here are some of the most common ones:

Standard VAT Accounting

Under this scheme, businesses charge VAT on their sales, reclaim VAT on their purchases, and submit VAT returns to HM Revenue & Customs (HMRC) at regular intervals. VAT returns are submitted to HMRC usually on a quarterly basis, detailing the output and input tax amounts. The business pays the difference between output tax and input tax to HMRC.

Cash Accounting

This scheme allows businesses to account for VAT on the basis of cash flows. VAT is paid to HMRC when customers pay for goods or services, and VAT can be reclaimed when the business pays its suppliers. Cash Accounting can help with cash flow management as VAT payments are based on actual receipts.

Flat Rate Scheme (FRS)

The FRS simplifies VAT accounting for small businesses with a turnover of up to £150,000 (excluding VAT). Instead of calculating and reclaiming input VAT on each purchase, businesses pay a fixed percentage of their turnover as VAT to HMRC. The fixed-rate varies depending on the business sector and helps account for VAT on purchases. Although input VAT cannot be reclaimed (with some exceptions), the simplified calculations often result in a net VAT saving.

Annual Accounting

With the Annual Accounting scheme, businesses submit VAT returns once a year instead of quarterly. Businesses with an estimated VAT taxable turnover below £1.35 million can use the Annual Accounting scheme. They make interim payments throughout the year. At the end of the year, the actual VAT liability is calculated, and the business either pays the balance due or receives a refund.

Retail Scheme

This scheme is designed for businesses in the retail sector. It simplifies VAT calculations by allowing businesses to apply a predetermined percentage to the gross takings to calculate their VAT liability.

Margin Scheme

The Margin Scheme is applicable to businesses that deal with second-hand goods, works of art, antiques, or collectibles. VAT is calculated on the difference between the purchase price and the selling price, rather than the full selling price. This scheme is beneficial when businesses buy goods from non-VAT registered individuals or entities. The Margin Scheme helps avoid double taxation on the same goods.

Remember, each scheme has specific eligibility criteria and potential advantages or disadvantages depending on your business type and circumstances. It’s essential to consult with your accountant for precise information tailored to your situation.

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