The mechanics of VAT under the standard VAT scheme
VAT on Sales
If you are VAT registered and selling VATable goods or services (most are) then you must add 20% VAT onto all your sales invoices. At the end of your VAT quarter (3 month period) you then have to hand over the total amount of VAT you have collected on your sales to HMRC.
On your sales invoices you must detail the exact amount of VAT being charged and also reference your VAT number.
VAT on Purchases
If you are VAT registered you are able to reclaim the VAT that you pay over to your suppliers through your quarterly VAT return.
To find out how much VAT you normally pay you can check your invoices and receipts. If there is any VAT to be reclaimed then the invoice will detail the amount you paid.
If you don’t have a valid VAT receipt then you can’t reclaim the VAT.
Do you need to register for VAT?
Most businesses must register for VAT if their total sales over the last twelve months exceed £77,000 (threshold as of February 2013).
If you are selling a product or service that is VAT exempt then these sales do not contribute to the £77,000. Most businesses do not sell exempt goods and services, generally the ones that do are providing what the government considers to be a social good, such as healthcare, public trasport, books and basic food. Financial services are also exempt.
Should you register for VAT even if you are below the threshold?
Just because you have sales of less than £77,000 doesn’t mean you can’t register. It may be advantageous for you to register. In order to decide you need to think about your sales and purchases.
If you are making sales to businesses rather than individuals then it’s likely that those businesses will be VAT registered and won’t mind if you charge them an extra 20% for VAT as they can just reclaim it back from HMRC. Whereas individuals who are not VAT registered won’t be able to claim back the VAT so won’t like the extra 20% charge at all.
The advantage of registering is that it means you can reclaim the VAT you hand over on your purchases. Unless your expenses are limited to public transport or international imports it’s likely you hand over some VAT from time to time.
So in short you will probably benefit from being registered for VAT if your customers are VAT registered themselves.
Different VAT schemes
Above we described the standard VAT scheme there are some variations that you might want to consider:
VAT Cash Accounting – Here you pay over the VAT in line with actual cash payments rather than invoices raised. In the standard scheme if you raise a sales invoice but haven’t been paid for it yet you must still hand over 20% to HMRC. Under cash accounting you only pay over what you have been paid yourself.
VAT Flat Rate Scheme – Under the Flat Rate Scheme you hand over a fixed percentage of your sales to HMRC but cannot claim any expenses (unless you buy some equipment costing more than £2,000). This tends to be extremely advantageous for businesses with very few outgoings, such as contractors. Read more about the Flat Rate Scheme here.