VAT Explained: What is VAT and How Does it Affect Your Small Business



VAT affects every business type in the UK, be it a small enterprise, a medium business, or a large corporation. As your business starts to grow, you have to get registered for VAT. So, it becomes essential to understand the VAT rate and how VAT preparations are done. These have to be accurate in order to avoid penalties. VAT outsourcing is an ideal way to go, but this guide will help you understand the basics.

What VAT Actually Means for Small Businesses

VAT is a tax that is levied on consumers spending as well as on imports. Businesses are required to get registered for VAT in the UK when the taxable income exceeds a certain threshold. So, VAT preparation becomes mandatory for businesses exceeding the minimum value of supplies or incomes as standardized by the government.

How VAT works

Once your business has registered for VAT, you must:-

  • Charge VAT at 20% (standard VAT) on goods or services sold to customers and other businesses
  • Pay VAT on goods and services purchased or rendered
  • File VAT returns every quarter to HMRC (HM Revenue & Customs)

The idea here is that the VAT you charge and the VAT you pay balances out and any difference is sorted out via your VAT return. In such a case, you end up paying HMRC the amount you owe or receive a refund for the amount they owe you for extra VAT you paid on goods and services.

The Benefits of VAT Registration for Small Businesses

  • Your business can charge VAT on the sale of all goods and services
  • Your business can appear stronger and bigger. If your business is VAT registered, it portrays a stronger image in front of customers, investors and suppliers.
  • Having a VAT registration number also adds credibility to your business
  • VAT preparations pertain several cash flow planning opportunities 
  • Potential gains are also possible through the Flat Rate Scheme (FRS)

The Cons of VAT Registration for Small Businesses

  • Business or profits are affected if customers are unable to recover VAT
  • Impact on cash flow
  • Additional administration expenses
  • Penalties are implied if errors are made while VAT preparation

The Making Tax Digital Program

With the government efforts to digitize tax filing for VAT and income tax, VAT outsourcing has become the new trend for accounting. By introducing the Making Tax Digital program, the government is aiming to simplify the process of VAT submission, helping businesses automate payments and returns. This program will not only help simplify the process for small business but will also put an end to tax-evading activities, decreasing the overall costs incurred by HMRC.

Alternative VAT Schemes for Small Businesses

Businesses that sell their goods and services to other VAT registered businesses end up experiencing less disruption as compared to selling goods and services to non-VAT registered enterprises. When you sell to a VAT registered business, the customers simply apply for VAT credit and get a refund for the VAT they paid from the HMRC. But, if you sell to unregistered businesses, you will be charging what amounts to a price increase of 20% and the other business will not be able to claim the VAT they've paid.

To overcome such situations, the government has put in place several alternative VAT schemes to help small businesses.

  1. Flat Rate VAT Scheme

Businesses with annual incomes of £150,000 or less can pay VAT under the FRS scheme. All VAT preparations are made on the basis of the total VAT-inclusive turnover, ultimately, making it easier for small businesses to submit returns since the sale to unregistered businesses doesn't need to be submitted. Businesses cant reclaim VAT on any purchase made under the FRS scheme. However, a lower percentage rate is designed to take account of this that ranges between 9-14%.

2.               Cash Accounting Scheme

Under this scheme, businesses only have to pay VAT when they have been paid by their customers. For instance, if you have made a sale to a non-VAT registered business, you don't have to pay any VAT for that particular transaction. This scheme is available only to businesses with an annual turnover of no more than £1.35 million.

3.               Annual Accounting Scheme

Businesses submitting VAT under this scheme don't have to submit a quarterly return. They can make nine-monthly payments, complete one return at the end of the year, and then pay any remaining balance owed or receive a refund at the end of the year. This scheme makes VAT outsourcing easier. It is available only to businesses who have turnover under £1.35 million.

Wrapping Up!

Regardless of the type of business you are running, you cannot ignore VAT. Understanding the VAT rate and schemes is a necessary part of accounting. This may seem intimidating at first, but if you get the hang of it, VAT preparation seems as easy as pie. But most businesses hire accountants since the calculation of how you can charge it successfully to avoid penalties is vital. VAT outsourcing significantly helps you stay organized and compliant with all VAT rules and regulations. This accounting task is better left to professionals, so it is advisable to hire VAT outsourcing companies and take this tedious task off your hands to focus on running your business.
Location: United States

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