Managing VAT for small businesses

How does VAT work? 

VAT is a tax charged on some goods and services provided by businesses in the UK. The standard rate of VAT is 20%, but a reduced rate of 5% applies to certain goods and services, including gas and electricity used in the home. Some items, including books, children’s clothes and most foods, can be purchased VAT free, meaning you pay 0% tax on them. 

If you register your business for VAT, you must charge this tax to your customers and then pay the VAT you’ve collected to HMRC every quarter. However, you’ll also be able to claim back any VAT your business has had to pay as an expense. 

When you complete your VAT return, you pay HMRC the difference between the VAT you’ve charged your customers and the VAT you’ve paid. Or, if you’ve paid more in VAT than you have received from your customers, you can claim back the difference. 

Who needs to register for VAT?

If your VAT taxable turnover over the last 12 months is more than £85,000, you must register your business for VAT. Your VAT-taxable turnover is the total value of everything you sell that’s not exempt from VAT.

If your turnover is less than £85,000, you can register for VAT voluntarily, but you should weigh up the pros and cons to make sure it's the right decision for your business.

What are the pros and cons of registering for VAT?

Pros

• If you buy large quantities of goods from suppliers that charge VAT, you’ll be able to claim this back against the VAT your own business charges

• Your goods and services may be more attractive to other businesses because they can reclaim the VAT they pay

• Being VAT-registered can make your business appear more credible and trustworthy

Cons

• There’s more admin involved as you need to submit quarterly VAT returns

• You need to charge VAT on your taxable goods, which means they’ll be more expensive (unless you reduce your margins)

• If the amount of VAT you need to pay outweighs the amount you can claim back, you could end up with a hefty tax bill

When does a business pay VAT?

A VAT-registered business needs to submit a VAT return one month and seven days after the end of each quarterly (three-monthly) accounting period - even if there is no VAT to pay or reclaim.

If any VAT is due, you must pay it by the same deadline, so check that you’ve left enough time for the payment to reach the HMRC account. 

How do I register for VAT?

You can register for VAT online on the GOV.UK website. If you operate a limited company, you will need to provide:

• Your company registration number

• Your business bank account details

• Your Unique Taxpayer Reference (UTR)

• Details of your annual turnover

If you’re registering as an individual or partnership, you need to provide:

• Your National Insurance number

• A form of ID, such as a passport or driving licence

• Your bank account details

• Your UTR, if you have one

• Details of your annual turnover

You’ll also need to create a Government Gateway user ID and password if you don’t already have one. Once registered, you’ll receive your VAT number, which you must include on all invoices you send. 

How do I submit a VAT return?

All VAT-registered businesses in the UK must sign up to Making Tax Digital (MTD). You can then use MTD-compatible accounting software, such as Xero, QuickBooks or Sage, to submit your VAT return online to HMRC. Using this software makes keeping and submitting records fairly straightforward, which should help you complete your VAT return. Alternatively, you can appoint an accountant or agent to submit a VAT return on your behalf. 

If you use the Annual VAT Accounting Scheme, you can use your VAT online account to submit your return. But you can only join the scheme if your estimated VAT-taxable turnover is £1.35 million or less. With this option, you only need to submit one VAT return a year, but you must make advance VAT payments towards your VAT bill. It’s best to speak to an accountant or tax adviser if you’re considering doing this. 

How to calculate your VAT return

To do this, you need to:

• Calculate the total amount of VAT you’ve collected on sales (output VAT)

• Calculate the total amount of VAT you’ve paid on business-related expenses and purchases (input VAT)

• Deduct your input VAT figure from your output VAT

If the figure you end up with is positive, you’ll need to pay that amount to HMRC; if it’s negative, you are due a refund. 

For example, if your output VAT is £3,000 and your input VAT is £2,000, you owe £1,000 to HMRC. 

But if your output VAT is £2,000 and your input VAT is £3,000, you can claim back £1,000.

What to do if being VAT registered is killing your business

If your business is struggling because of tax, it's best to speak to an accountant who can advise you on the types of tax relief your business could qualify for to help you save money. It’s also sensible to plan ahead and set aside a percentage of your monthly turnover, perhaps in a separate bank account, to help you pay your tax bills when they’re due.

In some cases, it might be possible to deregister from VAT. But to do this, your business needs to be under the VAT deregistration threshold of £85,000. You must also cancel your registration if you cease to trade or make VAT-liable supplies, or if you join a VAT group.

You need to log on to your online account to cancel your registration. Once deregistered, you should receive a confirmation from HMRC within three weeks of the request being made. 

Once your registration has been cancelled, you’ll need to submit a final VAT return for the period up to and including the cancellation date.