Ah VAT…. Probably the least understood tax by many people. This is mainly because it’s actually pretty complex! You may not yet be VAT registered, are considering it or have been for some time. In any case it is a good exercise for a refresher on what VAT can mean for your business.
So, What is VAT?
VAT, or Value Added Tax is a tax that is added to sales of many goods and services. Not all services or goods have VAT added to it (the law determines what). If the business you are buying from is not ‘VAT Registered’, their goods or services will not have VAT added to the price.
A few examples of items that do not have VAT on generally are:
Education provided by bodies like colleges and universities
Your house rent
Who pays VAT?
In reality it is us, the consumer that actually pays the VAT. Unless the business is on the small end of the scale you will be paying VAT. Its often not a concern because as consumers we just see the price tag.
For example, if you have bought a TV from one of the big supermarkets, say for £600, you’ve actually paid £500+VAT of £100. This £100 is taken by the supermarket and handed to HM Revenue & Customs when they complete their VAT return. Only the £500 is ‘their’ money.
One psychological quirk we often see is people become more aware or concerned they are paying VAT when its clearly marked on an invoice. It is something we often hear from our larger builder clients who are VAT registered, that their customer remarks on having to pay VAT, even though they are paying VAT everyday on most things they buy!
When do I need to go VAT registered?
There is a ‘Registration Threshold’ that often changes year by year. This determines when you have to VAT registered. Without getting too technical about it, in simple circumstances if your sales are more than the threshold, you need to register. In many circumstances you can voluntarily register before this threshold. In some situations this is very much a benefit.
At the time of writing, the threshold is £85,000 in a 12 month period. One thing to note about this period is that it is a ‘rolling’ period. What this means is – presuming you haven’t exceeded the threshold in your first 12 months – you then need to start tracking each new month and stacking it on top of this figure, removing the same month from the year before.
Jan – Dec 2018, you did £70,000. When you complete Jan 2019, you would knock off whatever you did in Jan 2018 and add Jan 2019’s figure.
If you have exceed the threshold, you would need to register. You have 30 days to do this, so if in Jan 2019 you exceed the threshold, you would become registered on 1st March 2019.
Without going into too many specifics here, there are cases when you cannot be registered (for example you make ‘exempt only’ supplies).
You also can apply for an ‘exception’ from registration if you can prove you temporarily went over the threshold (say you had one large one off job that tipped you over the threshold), and can demonstrate you will not exceed the threshold in the next 12 months.
How does it affect my business?
If you are supplying your goods or services to mainly (or entirely) VAT registered businesses, there is a good chance a VAT registration will not adversely affect your business and in fact will benefit you. If you are dealing the public mainly, you will have to take a good look at how this will affect your business.
Whilst you must charge VAT when registered, you can then offset any VAT you are being charged from your suppliers against any amounts you have collected from customers. You will see this in practice below. This means that you no longer ‘pay’ VAT on most of the goods or services your business buys.
Example, let say you own a Hairdressing Salon that now must be VAT registered
Before you were registered:
You currently charge £120 for a full hair ‘do’.
Your colours etc cost £24.
Your profit is £120-£24 = £96.00.
If you were VAT registered the next day and did not adjust your pricing you would be:
(The customer is still paying the same to you, and physically you are paying the same amount to your colour supplier, but the figures are a lot different).
The cut is now actually £120 = £100.00 + 20.00 VAT.
The colour is now £24 = £20.00 + £4 VAT.
£100 – £20 = £80 profit, compared to £96.00.
Your ‘VAT bill’ is £20 you have collected, less £4 incurred. You would hand over £16 to the VAT man when you do your next return (monthly, quarterly or annual – quarterly is the norm).
In order to make the same £96, your pricing would actually need to:
£139.20 for the hair do (£116 + 23.20 VAT).
This would make your profit £116 -20 = £96.
The problem arises if you cannot charge the customer this extra (or feel you can’t). For example if the price of the Salon across the road is £120 (or less), you may feel you cant charge £139. Your mission is then to work out the impact of the VAT and look to plan around it. Could differentiate yourself from the market to command a premium price, or look at ways to bring in additional income to offset some of the profit you would be losing.
The other thing this doesn’t take into account in the simple example, is that you may also be saving VAT on your ’overheads’. For example you phone, some utilities, often commercial rent etc will have VAT on that you will now be recovering, so its always worth looking at the overall situation before deciding what to do with your prices.
If your customers are VAT registered businesses, they will not care about the VAT you will now have to add on top of your services or goods, as they can recover VAT in the same way you now can. In this situation its therefore often a benefit to your business as you can simply add the VAT to your normal price AND recover the VAT you are being charged.
So I can claim VAT back on everything once registered?
The simple answer here is NO. There are some areas where VAT is ‘blocked’, which means although you will be charged and pay VAT you will not be able to reclaim it.
One common example of this is where you take a client or customer out for a meal to discuss business. This is classed as ‘entertainment’ and no VAT is reclaimable here.
If completing your own VAT return you will need to be fluent in the VAT rules, as there are many quirks! Our favourite example of this is the tale of ‘Jaffa Cakes’.
No VAT is charged on plain biscuits or general cakes (in the same way most ‘food’ from the supermarket won’t have VAT on it).
However, when you add chocolate to the biscuit it becomes ‘luxury’ and has 20% VAT added to it.
HMRC challenged the makers of Jaffa Cakes on this point, as they felt they were a biscuit, not a cake. They lost, and the courts decided they were cakes, therefore no VAT!
We could chat about what happens if you put chocolate trousers on a gingerbread man, or why Bourbons aren’t luxury….. but maybe that is another blog!
As you can hopefully see from the examples, VAT can often be a beneficial thing, but equally can be something you must consider and plan for if dealing with the non VAT registered people or businesses.
If you are VAT registered, we would always recommend professional advice be taken with your returns and certainly before registering, to fully understand the impact.
We help many of our clients complete their VAT returns as part of our service, to ensure they are maximising what can be claimed, and peace of mind it is correct! As with all things ‘tax’, HM Revenue & Customs apply penalties and surcharges to any errors they spot, or returns not submitted.
If you need to chat about your VAT concerns, problems or questions, please give us a call 02392 240040.
NOTE: As we started with, VAT is a very complex tax, so advice should be sought on your exact situation before deciding if a VAT registration is for your business. These simple examples could not possibly take into account all the various options that could affect the figures or commentary shown here.