VAT probably wasn’t the first thing on your mind when you started your business. Between drawing in your first customers and handling the initial admin, there are plenty of other things for small business owners to think about.
But turnover can add up quickly once you’ve been established for a while, and before you know it, you could be nearing the £85,000 threshold for VAT registration.
Unfortunately, small business owners don’t always know exactly when they need to register for VAT under law, and those who are aware of the threshold sometimes hold their businesses back from going over it.
Here’s what you need to know – and why you don’t need to fear VAT.
Understanding the VAT system
To start with the basics, VAT stands for ‘value-added tax’. It’s a type of consumption tax, applied at each point in a supply chain where value is added to a product or service.
This isn’t like income tax or corporation tax, for example, which you pay on your business’s profit after expenses are deducted. In fact, technically speaking, you’re not being charged at all – your customers are.
Registering for UK VAT means you become responsible for collecting this tax from your sales on behalf of the Government.
This is generally done by adding an extra amount to your sales price, although some businesses choose to keep their prices the same and absorb the cost.
When do you need to register for VAT?
By law, you’re required to register when your VAT taxable turnover exceeds the threshold of £85,000 in any 12-month period.
Your VAT taxable turnover is the total value of everything you sell that is not exempt from VAT. (You can find a full list of VAT rates, including exemptions, here.)
You must register if either one of these scenarios apply:
- you expect your VAT-taxable turnover to be more than £85,000 in the next 30-day period, or
- your business had a VAT-taxable turnover of more than £85,000 in the last 12 months.
That second point is particularly important for small business owners.
Unlike many other tax thresholds, this doesn’t just apply to a particular tax or financial year – it refers to any 12-month period.
To ensure you don’t go over the threshold without realising it, you need to be checking your turnover at least every month.
Once registered, you’re required to charge the correct amount of VAT, following the rates and exemptions in the link above, and pay it to HMRC.
You’ll also be required to keep digital records and provide updates to HMRC under the rules for Making Tax Digital for VAT.
This currently applies if your taxable turnover is more than £85,000, but from 1 April 2022, all VAT-registered businesses will be included.
Why should you register for VAT?
Understandably, a lot of business owners are put off by those additional record-keeping and administrative responsibilities, as well as the risk that they could end up undercut by competitors that don’t have to factor VAT into their prices.
As a result, some choose to deliberately stifle their business’s growth so they stay just under the VAT-registration threshold. Others might look for alternative strategies, such as splitting their business into different parts.
In a 2017 report, the Office for Tax Simplification noted a significant number of businesses were taking the first option, also known as ‘bunching’, with data showing high numbers of businesses before the turnover threshold and a sharp drop-off after it.
Holding your business back from a higher turnover, whether that’s by turning down a big contract or limiting the size of your team, is obviously not the best long-term strategy if you have the potential to grow.
And the second option, known as ‘disaggregation’, is dangerous territory to get into if your main concern is VAT.
While there may be legitimate reasons to split up your business, HMRC views this as tax avoidance if you’re doing it artificially, and may compulsorily register you for VAT.
What’s more, your case could be treated as late registration if you’ve been operating this way for some time, which means HMRC can demand VAT in arrears for up to 20 years and penalties may apply.
Plus, it’s not all bad news. Registering for VAT comes with some benefits, the main one being that it allows you to reclaim VAT on your own expenses.
When your business purchases supplies from another VAT-registered business, you’re paying VAT to them as part of that transaction.
Once you’re registered for VAT, you can start offsetting those costs against your VAT bill.
This can help you to recoup some costs, and in some cases, it might even be beneficial to voluntarily register before you hit the VAT-registration threshold.
Whatever your circumstances, getting advice from an expert is the best way to ensure all your VAT obligations are met.
Don’t struggle alone – get in touch for support with VAT returns and registrations.