If your creative business is growing quickly, you may need to seriously consider registering for VAT.
But how do you know if now is the right time to make this business-critical decision?
And what are the implications of registering or not registering for VAT when you reach, or get close to, the current VAT threshold?
To help you decide on the most sensible and cost-effective way forward for your company, we’ve answered all your burning questions on this topic below.
First thing’s first – what is VAT?
It’s one of those phrases that’s firmly rooted in our business vocabulary, but do you know what VAT actually is, and why companies need to pay it?
VAT stands for Value Added Tax. It’s a consumption tax that is placed on all goods and services that are sold within the UK. The percentage of tax that needs to be paid on a product very much depends on the value of it, but the key thing you need to remember is, it’s the customer who foots the bill for VAT – not your business. Think of VAT as something that simply needs to be added to your fees as an additional cost, not something that serves to drive up your prices.
Currently, if your taxable turnover is below £85,000, you will not need to become VAT registered (although you may want to take the plunge early; we’ll explain why shortly). If you earn more than this £85,000 threshold, you must register with HMRC.
It’s worth noting that, when you first register for VAT, any earnings made before you reached the £85,000 limit do not count. Only monies earned after you’ve reached the £85,000 threshold will be subject to VAT. So, for example, if your company turns over £100,000 in its best growth year, only £15,000 of this total will be considered taxable turnover. In future years, you’ll need to pay VAT on all taxable earnings.
How much VAT will you need to charge?
The standard rate of VAT is 20%, which applies to most goods and services. But there are a handful of other types of VAT to consider:
Reduced rate VAT: This is set at 5% and applies to items that your customers would consider to be a ‘luxury necessity’, such as children’s car seats and/or mobility equipment designed to assist elderly or vulnerable individuals.
Zero rate VAT: You will not need to charge VAT on certain essential items, including a vast array of food and medical supplies, and other vital purchases, like children’s clothing.
Exemptions: Some services are exempt from VAT, including education and training; financial services, such as those within the insurance and investment fields; and some medical treatments.
As you can see, the rate of VAT you charge will very much depend on the products or services you’re selling. But remember, even if you are able to charge no VAT on certain sales due to the sale type or existing exemptions, you will still need to record all these rates on your VAT return and send this information directly to HMRC.
How do you complete a VAT return?
When you are VAT registered, you must send a statement of all your tax payments to HMRC every quarter. Your VAT return will need to include:
- Information on the sales of all goods and services that are VAT-able
- The rate that applies to each of these sales
- How much you owe the government in tax
You can submit all your VAT returns digitally. In fact, platforms like Quickbooks Online makes light work of these processes, as all data is stored in the cloud and then shared with HMRC at the click of a button. It’s just one of the reasons why Quickbooks is our accounting software of choice!
Once you know how much VAT the government will be charging you on all your sales within this three-month period, you must set this amount aside so you have the funds to pay your VAT bill. However, there are some ways you can reduce the total payable to HMRC.
Reclaiming VAT on your own purchases
To offset some of the costs associated with charging VAT, you can reclaim VAT on the VAT-able purchases you have made within your own business. These kinds of purchases include office supplies, computers, software subscriptions, and advertising and marketing costs – so, the things you would typically buy to keep your operations moving.
This article from Startuploans.co.uk contains lots of information on the VAT that can be claimed back on various different company expenses.
You won’t be able to claim for anything that’s purely for personal use, but you can claim a percentage of the cost if you use the item or service for occasional business use. Those of you running your creative businesses from home might be pleased to learn that you can claim back a proportion of VAT on the services you need to stay afloat, including your broadband packages and your utility bills. (Given the rising cost of living, this might be something to explore if you haven’t submitted any similar claims to date.)
If you have paid more in VAT through business expenses than you have actually earned within any three-month period, you will be entitled to a VAT refund. On the other hand, if you have earned more than you have paid, but have still paid some VAT when buying goods and services to benefit your company, you will effectively be able to reduce your overall VAT bill.
When you register for VAT for the first time, you can use your initial VAT return to claim back previously incurred VAT costs on a range of expenses and services from the last four years, as long as you can:
- Provide proof in the form of VAT receipts
- Prove that you still own and use the items you purchased
- Prove that you purchased particular business services within the last six months
What are the benefits of being VAT registered?
Having a VAT registration number often makes smaller businesses appear larger and more established than they are. In fact, many companies prefer their suppliers to raise valid VAT invoices, so they can claim back the VAT on their own purchases with ease. So, if you are struggling with your corporate image and want to give your brand more authority and credibility, registering for VAT sooner rather than later may make sense.
You may also benefit from registering for VAT if you are planning to invest heavily in your systems and equipment, because eventually you may be able to claim back more VAT than you pay.
And what are the downsides?
As a smaller business with a significantly lower income than many major players in your industry, you probably rely on charging competitive prices to secure your sales and keep the cash coming in. If you register for VAT, you will need to factor these charges into your own fees, which means you will either need to increase your prices or absorb the costs and expect your income to decrease.
Higher prices are less attractive to money-conscious purchasers, especially when you’re dealing with B2C markets – so if you’re servicing this kind of customer base, you may want to keep your turnover below the £85,000 threshold to avoid significant hikes that might price you out of range.
If you don’t purchase a high volume of goods or services for use within your business, you won’t be able to claim substantial sums back in VAT. Plus, you will need to either make provisions to manage the quarterly VAT returns yourself or instruct your accountants to take care of these submissions for you, which may result in extra charges.
You haven’t reached the VAT threshold yet – should you register now?
If your turnover is well below the threshold, weigh up the pros and cons carefully before deciding on the best way forward. Registering for VAT now may support your strategy for growth – but on the other hand, you may alienate potential customers and/or create unnecessary admin for yourself and your teams in the short term.
If you are getting very close to the threshold, you have two choices: you can either bite the bullet and set yourself up with HMRC so you know you’re going to be covered, or you can work to keep your earnings underneath £85,000 so there is no legal requirement to register. Taking the latter approach will obviously cap your future earning potential, so we wouldn’t recommend this route if you have plans to expand.
What happens if you forget to register before you go over the threshold?
If you forget to register for VAT, you have 30 days from the date at which you exceeded the tax threshold to get in touch with HMRC and add yourself to the VAT register. If you don’t, you will usually need to pay a penalty.
The precise charge will depend on a range of factors; if you reported the error, it’s likely that HMRC will go a little easier on you than if they spotted the oversight themselves!
Still not sure if you should register for VAT? We’d love to support you. Contact AO Accountants today for advice and help setting up your account with HMRC.
