VAT: The Basics

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This post may be a little basic for most but I think it is still important to remind ourselves of the basics to VAT every once in a while. It is especially important when there are thresholds and regulations that are likely to change on an annual basis. It seems to me that often we as professionals assume that clients know and understand the basics of VAT as we all pay it on a daily basis, unfortunately this is not the case and often times small business owners are overwhelmed by the task of preparing a VAT return and the result is that mistakes are made which can lead to problems further down the road.

At the risk of stating the obvious, the current VAT rates are:
Standard rate -20%
Reduced rate – 5%
Zero rate -0%

I suppose the first thing that should be addressed is the VAT threshold. The current registration threshold is £81,000 in any 12 month period. This means that you should monitor your turnover constantly not just at the end of your accounting year. As soon as you see you will breach the turnover threshold, you must register for VAT. You can register online here https://online.hmrc.gov.uk/registration/options. If however you are registered for VAT and your VAT taxable turnover falls below or equal to £79,000 and is expected to stay at that level then you can opt to deregister from the VAT system.

Once you determine that you need to register for VAT, the next question you may ask is ‘Which VAT accounting scheme should I adopt?’ There are 7 VAT Accounting Schemes that HMRC will allow you to use depending upon your circumstances.

Standard/Accruals Accounting

You account for all sales and purchases in the month that they occur, NOT in the month in which the invoice was paid. If your business is cash flow sensitive then this may not be the best option for you especially if you typically get paid more than 30 days after your invoice date. This is generally the HMRC’s preferred method of accounting for your VAT. Equally, from an accountants point of view there is less adjustments to make at the end of the financial year as you have already accounted for the VAT on all invoices.

Cash Accounting Scheme

Unlike the Standard/Accruals scheme, under cash accounting rules, you only pay over the VAT on the difference between your sales and purchases once these invoices are paid by yourself and your customers. This is aimed at helping businesses who are cash sensitive to pay the VAT more easily. Please do note however that you can only be in the Cash Accounting scheme provided your annual turnover is less than £1.35m.

Flat Rate Scheme

If you are a business that has a small turnover (ie less than £150,000) and few purchases that are subject to VAT, then you may want to consider the Flat Rate Scheme. This is a simplified method of accounting for your VAT by paying to HMRC a fixed percentage of your sales income at each return. You do not need to calculate the difference between the sales and purchases. When you make your application for VAT registration and inform HMRC you wish to use the scheme, they will tell you what percentage you will be subject to pay on your return. To check in advance you could refer to the following http://bit.ly/1f5TFZ0. Please note that you do not reclaim VAT on your purchases except for some capital purchases over £2,000.

It is important however to consider if this is the right scheme for you. If you are likely to have very small payments to make with each return or even if you are likely to receive a refund regularly then this is not likely to be a suitable option for you.

Annual Accounting Scheme

In my experience, this is not a scheme that is often used by small businesses. As the title indicates, you only submit a VAT return once a year rather than quarterly. This does not mean however that you only pay once a year. Each quarter you still make an advance payment to HMRC based upon your last submitted return. When you do make your return you then either pay the difference to HMRC or request a refund if you are due one for overpayment. You can only enter this scheme if your annual turnover is less than £1.35m.

figuresThe final 3 schemes are more specialist schemes and you should seek professional advice if you feel you need or should be adopting any of the below. They are too detailed to go into in depth but I will give you a very quick note about each one.

Retail Scheme

This scheme is aimed at, you guessed it, businesses who sell goods. The aim of the scheme is to make the calculation simpler. Instead of doing the calculation for each individual transaction, you do it once foreach return you submit. if your turnover is below £130m then you can use one of the standard schemes below, otherwise you must agree a bespoke schemewith HMRC;

  1. Point of Sale Scheme
  2. Apportionment Scheme
  3. Direct Calculation Scheme

To read in detail about these schemes go to http://bit.ly/1z3RaEo.

Margin Scheme

The margin schemes are used to calculate the difference between the purchase price and the selling price of a particular item and the VAT thereon. You can use the margin scheme if you sell any of the following:

  • second-hand goods
  • works of art
  • antiques
  • collectors items

Once again, please seek advice from a professional if you need/want to use a margin scheme as there are exceptions and lots of considerations to be made.

Tour Operators Margin Scheme

This scheme is currently causing me the most headaches, a very specialist area that even HMRC seem to struggle to give accurate and useful advice on. Like the Margin Schemes above, the VAT is calculated on the difference between the purchase and selling price of a tour package, transport or accomodation booking, however not all transactions are subject to VAT. Lets just say seek advice from a professional, confusing and befuddling does not even go partway to explain the difficulty of TOMS!

I hope the above has been of some help and should you have any questions please do not hesiate to ask your accountant or bookkeeper or even pick up the phone and speak to HMRC. As always, I am also always available to help where I can.

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