VAT (Value Added Tax) is an indirect tax that is added to most products and services sold by VAT registered businesses.
Businesses must register for VAT either when they expect their turnover to exceed £85,000 or the VAT taxable turnover for the past 12 months was over £85,000.
A company can choose to voluntarily register for VAT at any point, however, upon reaching these thresholds, VAT registration becomes mandatory.
There are 3 rates of VAT chargeable in the UK:
• The standard rate charged at 20%
• The reduced rate charged at 5%
• The zero-rate charged at 0%.
Most companies will be required to charge VAT at the standard rate and, depending on the mechanics of their chosen scheme, will pass this onto HMRC.
Flat rate or standard rate?
When registering for VAT a business will need to decide which VAT scheme it wants to use. This could be either the flat rate scheme (FRS) or the standard rate scheme (SRS) depending on the business meeting the qualifying criteria for each scheme.
Under the FRS, a business will charge VAT at 20% but only pass on a flat rate percentage of the invoice value including VAT (e.g. 16.5%) to HMRC. The flat rate percentage used is based on the businesses trade sector and any difference between any VAT charged and VAT paid to HMRC will be additional profit for the business to keep.
On this scheme the business can only reclaim VAT on capital asset purchases above £2,000.
The standard rate scheme requires the company to charge VAT at the standard rate of 20%, pass on the full 20% charged to HMRC and reclaim the full 20% of any VAT incurred on its own business expenses.
The difference between the VAT charged and VAT incurred is the VAT payable to HMRC.
There are benefits and downsides to each scheme and there is not a one size fits all approach, it is dependent on the activity of the company.
VAT Returns and Payment
Company accounting records are set up to itemise VAT on sales and on costs. At the end of each quarter this information is filed with HMRC and any difference in VAT received or paid from trading is settled with HMRC.