Value Added Tax (VAT ) explained by Chartered Accountants & VAT Specialists

In this Tutorial, we are going to take a closer look at Value Added Tax (VAT) and highlight a few aspects of this tax you may not be aware of, which could even save your business some money! 

VAT is a tax on consumer spending and is collected on behalf of the government by businesses who are VAT registered. Therefore these businesses are effectively acting as “unpaid” Tax Collector for HMRC.

A transaction is within the scope of UK VAT if all the following conditions are met:

• It is a supply of goods or services
• It takes place in the UK
• It is made by a taxable person (under UK legislation, a person is a taxable person while he is registered, or required to be registered under VAT Act (VATA) 1994 Schs 1–3A, and such persons are registered in a register of taxable persons maintained by HMRC)
• It is made in the course or furtherance of any business carried on by that person
• It is a taxable supply (not “Exempt”): a supply on which VAT is charged whether at standard rate (20%); reduced rate (5%) or zero rate (0%)

Certain supplies are exempt from VAT. This means that no VAT is chargeable but,

unlike zero-rated supplies, related input tax is not recoverable.

Two more key concepts to cover and understand are output tax and input tax.

Output Tax is the tax that is calculated and charged on the sale of goods and services from your business, if you are VAT-registered.

Input Tax is the tax which is added to the price when you purchase goods or services that are liable to VAT. A taxable person is entitled to reclaim input tax incurred on goods and services supplied to him, provided that the input tax relates to taxable business supplies made by him in the course of business.

Here are the “10 Things you didn’t (and quite possibly didn’t want to) know about VAT”:

1. You can register voluntarily for VAT with HMRC, despite not yet having met the turnover threshold for compulsory registration (currently £85,000 in 2017/2018 tax year), or even before trading has commenced. Whilst there is obviously an administrative burden, it can be useful to consider because:

• registering when already trading can make the process much more difficult, including  having to explain a 20% price increase when you need to start charging VAT on a compulsory basis. (you may even be forced to “share” some of the pain with your customers, impacting your business’ income!)
• Small businesses can give the appearance of being bigger and more established.
• if your customers are VAT registered they won’t be impacted & your business can reclaim the VAT you pay (Input Tax) to your own suppliers, adding to your profit & cash!
• you won’t have to worry about all the rules surrounding compulsory registration & keeping track of when you need to compulsory register your business (failure to register on time will lead to recovery of VAT that should have been charged as well as penalties)

2. If you make any payments due to HMRC by direct debit, you get up to an extra 3 days after due date before payment is taken out of your bank account (potential Cash Flow benefit)

3. VAT cannot be recovered on goods and services which are not used for business purposes (e.g. for private use). Where goods are used partly for business and partly for non-business purposes, the VAT incurred is apportioned. For example, a trader might have to apportion input tax on (mobile) telephone bills, where the telephone is used both for business and for private use.

4. Smaller & medium sized businesses (with turnover below £1.35m -excluding VAT; and on taxable supplies, so not counting turnover on “exempt” supplies) may apply to join the “annual accounting” scheme. This allows them to complete one VAT return each year, with 9 monthly payments on account required plus a balancing payment to be submitted together with the Annual VAT return. In the same way as Quarterly returns, the annual VAT return must be completed and submitted electronically to HMRC. However any balancing payment, needs to be be available to HMRC in cleared funds within two months of the end of the annual VAT accounting period (normal seven day extension does not apply to traders on annual accounting). Please note the scheme won’t suit your business if you regularly reclaim VAT because you’ll only be able to get 1 refund a year (when you submit the VAT return)

5. The VAT invoice is probably the most important document for VAT purposes. 

In order to be a valid VAT invoice it must show all of the following information:

• a sequential, identifying invoice number date of the supply the date when the VAT invoice is being issued
• The supplier’s name and address and the supplier’s VAT registration number
• The name and address of the person to whom the goods or services are supplied, a description sufficient to identify the goods or services being supplied, the quantity of goods or the extent of services supplied, the rate of VAT applicable and the amount that is being charged, which is net of VAT
• the quantity of goods or the extent of services supplied
• the total amount being charged, net of VAT
• the rate of any discount offered
• the total amount of tax chargeable, expressed in sterling
• the unit price
• N.B. Retailers are allowed to issue less detailed invoices as long as the supply is less than £250
• In addition there are some other very specific elements which are beyond today’s blog scope.

6. Smaller business (turnover < £1.35m, with similar provisos as under “Annual Accounting” scheme, see point 4 above) may use the Cash Accounting method, with Output Tax accounted for on date the cash is received and Input Tax accounted for when the cash is paid to the supplier. 

Advantages include:

• helps Cash Flow
• automatic Bad Debt relief
• it is easier to identify the tax point for transactions

7. A further potential simplification for smaller businesses is the “Flat Rate Scheme”, which is available for business with turnover (of taxable supplies excluding VAT) of  £150,000 or less.

 As an additional benefit, it give you a 1% discount if you’re in your first year as a VAT-registered business.

 It involves your business charging your customers the normal rate of VAT for your supply (i.e. 20% or standard rate for say Accounting Services), and pay a fixed rate of VAT to HMRC (VAT flat rate you are charged usually depends on your business type, but note that you may pay a different (higher) rate if you only spend a small amount on goods). 

For example for “Accountancy” the Flat Rate is 14.5% & for “Management Consultancy” it is 14%. 

Your business can keep the difference between what you charge your customers and the amount you have to pay to HMRC. This effectively reimburses you for not being allowed to reclaim any (Input) VAT on your purchases (other than on certain capital assets over £2,000). 

8. For accounting periods starting on or from 6 April 2019, the “Making Tax Digital” initiative will require businesses with turnovers above the VAT threshold (currently £85,000), to keep digital records for VAT purposes. For more information on “Making Tax Digital” have a look at our page on that topic.

9. VAT incurred on a number of items is non-deductible (“blocked”). The most common of these are motor cars (with certain exceptions) and business entertaining:

• Motor cars: VAT cannot be recovered on the purchase of a motor car. Also the VAT is not blocked on repairs for the car. There is an exception when a motor car is purchased and exclusive business use is intended (it is used only for business journeys and it is not available for private use). However if a business leases a car which is available for business and private use, in these circumstances the trader is able to recover 50% of the VAT on the lease charges. N.B. vans are not cars and therefore the VAT is not blocked, but this is a complicated area, so make sure you get professional advice before buying.

• Business Entertaining means entertainment (including hospitality of any kind) provided by a taxable person in connection with a business carried on (e.g. provision of food and drink; provision of accommodation (hotels, etc.); provision of theatre and concert tickets; entry to sporting events and facilities; entry to clubs, nightclubs, etc; and use of capital goods such as yachts and aircraft for the purpose of entertaining).

• Dual use: Where goods or services are used, or to be used, partly for business entertainment and partly for other business purposes, an apportionment of the input tax must be made between the entertainment and other business use, and only that input tax apportioned to entertainment cannot be recovered as input tax by the business.

• Staff entertainment: HMRC accept that where an employer provides entertainment for the benefit of its employees (e.g. to reward them for good work or to maintain and improve staff morale), it does so wholly for business purposes. As a result the VAT incurred on entertainment of employees (e.g. staff parties, team building exercises, staff outings and similar events) is input tax and is not blocked from recovery under the business entertainment rules, with exception of:

1. Where entertainment is provided only for directors, partners or sole proprietors of a business, the VAT incurred is not input tax as the goods or services are not used for a business purposes
2. Where employees act as hosts to non-employees, the costs are incurred solely for the purpose of entertaining the non-employees and the input tax is blocked under the business entertainment rules.

• Subsistence: where meals etc. are provided away from the place of work on a business trip, the VAT incurred on the employee’s meal can be claimed as input tax under the subsistence rules

• Staff parties with guests, etc. Where a business entertains both employees and non-employees, it can only recover as input tax the VAT it incurs on entertaining its employees. The portion of the input tax incurred in entertaining others is blocked under the business entertainment rules. However the input tax can be recovered if the business levies a charge on the non-employees attending the event.

10. You do not need a VAT invoice to reclaim Input Tax for some types of supply if your total expenditure for each taxable supply was £25 or less (including VAT) & you must be sure that the supplier was registered for VAT, namely:

• purchases through coin-operated machines
• car-park charges (on-street parking meters are not subject to VAT)
• a single or return toll charge paid at the tollbooth
• phone calls from public or private phones (if you can still find a pay-phone these days...)

In this Tutorial we have just covered the top of the iceberg as far as VAT is concerned. 

It is always worthwhile getting professional advice & a full review of your specific circumstances to ensure you not only comply with all regulations, but also maximise possible recovery of VAT.

Tulip Thistle Accountancy

Chartered Accountants & VAT Specialists