Starting in Business - Value Added Tax

Businesses quickly discover that they have to act as tax collectors for HMRC and may have to devote a lot of time to calculating and accounting for VAT. It is important to have a grasp of the VAT rules in the very early stage of the development of the business. HMRC leaflets (in particular "Should I be Registered for VAT?") are recommended as introductory reading.

Registration

VAT is a tax on business turnover and every business must register for VAT if its taxable supplies are more than the registration thresholds. These thresholds are normally increased in line with inflation each year. Please check with us for the latest figures.

Normally a business will only have to consider its taxable turnover over the previous 12 months, unless taxable supplies are expected to be more than the registration limit within the next 30 days.

Registration is compulsory if:

• at the end of any month, the total value of taxable supplies made in the past 12 months are more than the compulsory registration limit (check with us for the latest figure). A VAT form 1 must be completed and sent to HMRC within 30 days. The date of registration is the first day of the second month following the relative month;
• at any time there are reasonable grounds for believing that taxable supplies of more than the compulsory registration limit will be made within the next 30 days. The date of registration is the date when it is known that the limit will be exceeded;
• some VAT incurred on purchases before registration can be reclaimed and it is important to identify this. In particular, tax on services that have been bought can only be reclaimed if they were supplied no more than six months before the date of registration.

Penalties

Every non-registered business must watch the threshold very closely. If a business should have been registered at an earlier date, HMRC will levy VAT on the business turnover from the date it should have been registered, less any allowable VAT incurred on purchases.

Additionally, a penalty might be levied unless the business has a reasonable excuse for its failure to register. Ignorance of VAT rules is not an excuse.

Voluntary registration

If a business with a turnover of less than the registration limit wishes to register, then it may do so. An obvious advantage in ‘voluntary registration’ is that VAT on purchases may be recovered, whereas an unregistered business can only obtain relief if the cost of VAT can be deducted when calculating taxable profits.

In general, when supplying goods and services to the public, non-registration will allow a competitive edge to be obtained and might increase profits depending on the amount of VAT on purchases which cannot be reclaimed.

Goods and services from non-registered suppliers may not be attractive to VAT registered customers, because this will normally increase the cost to them. Nonregistration also indicates the size of the business and might reduce credibility.

Accounting for VAT

Every VAT registered person must account for ‘output’ VAT on the value of its taxable business supplies.

Most outputs are standard-rated and VAT has to be charged at 17.5%.

Some outputs are zero-rated. They are still taxable but at the zero rate of VAT. Other outputs are exempt from VAT. This means that no VAT is charged on the exempt supply.

The important distinction between an exempt output and a zero-rated output is that input VAT can be recovered if it relates to zerorated outputs, because they are taxable, but not if it relates to exempt outputs.

It is important that every business determines the correct rate of VAT to apply at an early stage, so that it charges all the VAT it must pay to HMRC, and it restricts its claims for input VAT to the portion reclaimable. There are penalties for large underdeclarations of VAT, unless there is a reasonable excuse. There are also interest charges where VAT is paid late.

The VAT return

A return of the value of outputs less inputs must normally be completed on a quarterly basis, and sent in within a month of the end of the quarter. Where output VAT exceeds input VAT, the balance must be paid to HMRC within a month of the end of the quarter, or up to seven days later if paying by credit transfer. There is a penalty system if returns or payments are made late. HMRC will accept monthly, rather than quarterly, returns, provided this is agreed with them in advance. The extra paperwork can be worthwhile if the business consistently reclaims VAT. This would occur where a business mainly makes zero-rated supplies, so that the value of inputs is more than the value of output VAT on standard-rated sales.

Small businesses – annual accounting

Small businesses with a turnover of less than £1,350,000 (From 1 April 2006) can use an annual VAT accounting system. Nine equal monthly payments are made by direct debit (based on an estimate of the total VAT due) and the tenth payment, to balance the account, is sent in with the annual return.

Cash accounting

Small businesses can account for VAT on a cash paid and received basis, rather than on an accruals basis, if their turnover is likely to be less than £1,350,000 (From 1 April 2007). Where a small business has to wait a considerable period to be paid by its customers, this method of accounting might be beneficial.

Special schemes

There are several special schemes which may be used by retailers to apportion sales that are both standard-rated and zero-rated. Discussion of the schemes themselves is outside the scope of this publication – refer to VAT Notice 727.

Partial exemption

A business that makes both exempt and taxable supplies has to make sure that it keeps adequate records of its supplies and purchases.

The bookkeeping system should allow for purchases to be segregated into those relating to exempt supplies and those of a standardor zero-rated nature.

Only input VAT on supplies attributable to taxable outputs can be reclaimed. Where the input VAT relates to a general supply that cannot be directly attributed, only a proportion of the VAT can be reclaimed. This is explained in more detail in HMRC leaflet ‘Partial Exemption’ 706.

Buying an existing business

Special VAT rules apply where an individual starts up in business by taking over an existing concern. If various conditions are satisfied, VAT will not be charged on any of the assets purchased.

HMRC will allow the new owner to take over the previous owner’s VAT registration number. This should normally be resisted because the new owner not only takes over the VAT number, but also any liabilities due to HMRC by the previous owner. The new owner should ask for a new VAT registration number. Further information can be found in VAT leaflet ‘Transfer of a Business as a Going Concern’.

• Here at Geoffrey Cole & Co., Chartered Accountants, Reading, Berks we have an extensive list of online resources available for FREE DOWNLOAD in our unique Info Vault.

• It is extremely important for all businesses to note that new and amended legislation may become applicable at any time.

Geoffrey Cole & Co Chartered Accountants & Registered Auditors offer a service that both encompasses and extends beyond the provision of traditional tax, auditing and assurance services. We believe in the value of an integrated approach to your financial needs and view a substantial part of our role as being that of business adviser. In this capacity, we work alongside you, helping you identify your immediate and long-term business objectives and plan for them accordingly. Communication is key and we maintain regular contact with clients in relation to their own affairs. Our IT capabilities are extensive: wherever possible your documentation will be prepared and processed electronically. Furthermore, as SAGE software suppliers and trainers our expertise with their business packages is second to none.

Our years of experience are reflected in the range of services we provide and our extensive client list.

Managing Director Geoff Cole says:
"Our aim, as Chartered Accountants, is to help you to achieve your personal goals and aspirations. Yes, we can deal with the compliance work such as audits, tax returns and the preparation of accounts but these are not the area of our principle focus"

“It’s about you.”