What Exactly Is VAT?

VAT is a tax system operated by many economies around the world, including the United Kingdom. VAT stands for Value Added Tax and is an additional fee on top of the price of the goods and services you offer. It is indirect taxation from the government on almost-all items and services sold. It is not additional revenue for a business. You charge for your products, the government then charges a percentage fee of that price, which you collect on behalf of HMRC and send to them as part of your VAT tax returns. The consumer pays both the product price and VAT.

VAT is charged at 20% of the value of the goods sold. This is known as standard rate VAT. There are exceptions to standard rate VAT. Some goods or services are exempt from VAT, while others come at a reduced rate or zero rate. You can find all the information about exceptional VAT circumstances here.

Should I Register for VAT?

So if you charge VAT, your customer pays more — but you don’t get any extra cash?
That doesn’t sound like something you’d want to be involved in. After all, 20% extra is a lot of money on some purchases.

Why not just avoid registering for VAT? Because VAT is not optional — you need to register. If you earn over the threshold for VAT payments — £90,000 as of 2020 — you must register for VAT.

You should register for VAT once you hit this mark. You do not have to register or pay VAT if you earn below the threshold, but once you have, you must charge VAT to customers and pay that money to HMRC through VAT tax returns.

What Happens If I Don’t Register for VAT?

Legal action is the short answer.

VAT payments are required by law, just like any other tax payment. Fail to charge VAT and you fail to take the tax that you owe. The result will be you have to cover the cost of VAT tax, rather than the consumer. If you try and avoid paying VAT altogether, then you’re conducting tax avoidance. Major financial penalties can occur — even jail time for serious offences.

It’s impossible to shoot under the radar with VAT payments. Once you hit the threshold of £90,000 a year, HMRC will know through your self-assessment statements. If you hit the VAT registration threshold, it’s time to start thinking about sending your VAT return.

Fail to do so, and you are breaking the law.

VAT Isn’t as Bad as It Sounds

Putting what is essentially a 20% price hike on everything you sell sounds like a terrible idea — especially when you don’t see any of that money yourself. However, there are ways to offset the costs of VAT and reduce the impact on your business and customers.

When you register for VAT, you not only pay VAT but you can also reclaim it. At this point, you’ll likely be familiar with tax expenses, the process of reducing your tax bill by claiming on goods and services you’ve paid for as part of business operation. You can reclaim VAT in much the same way.

What effectively happens is you create a VAT balance. VAT you’ve paid offsets VAT you owe. Let’s say you’ve paid a total of £1500 VAT as expenses for goods or services and have charged your customers £2000. This means you only have to pay £500 to HMRC, as you’ve already contributed £1500 of your £2000 total through your VAT payments.

Depending on your supply chain, and the products you sell, this may be a gross oversimplification, but it does demonstrate the point. By reclaiming VAT, and managing your accounting properly, you can offset costs of VAT and pass that saving onto the consumer, rather than charging lots more, allowing you to avoid massively inflated product costs.

By being aware of how much tax you’ll actually have to pay, you can start to look at options for adapting your pricing to be profitable and competitive.

Some important notes to remember are:

  • You can only reclaim VAT if you are VAT registered.
  • To reclaim VAT, you need a VAT invoice for purchases.
  • You can start charging and reclaiming VAT before reaching the £90,000, but it is not legally required.

 

Ready to register for VAT? The Mint Formations team are here to help. Our formations and registration experts can support your business and ensure you experience a quick and pain-free registration process.

 

Want to register your UK limited company today?


Raj co-founded Mint Formations with business partner Andy Tree in 2017. Mint formations is established to nurture small UK businesses and enable exciting new opportunities for quick growth. As a successful entrepreneur, Raj knows how to start and run a business. He currently resides as a board member of seven successful companies across the world. He is best known for founding Integra Global Solutions, specialists in robotics, automation, and business process optimisation.

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