The mysterious world of VAT – and why you should use the flat-rate scheme

10 July 2017

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We all know what Value Added Tax (VAT) is. It’s that 20% consumption tax that’s added to pretty much everything you buy that isn’t a basic, everyday product or service. But did you know that registering your business for the flat-rate VAT scheme can actually make you money?

Most business owners will see VAT as a pain – something that adds to your tax costs and creates a whole pile of admin – rather than a benefit to the long-term growth of your business.

But if you’re a small business, you can apply for the VAT flat-rate scheme – which simplifies the VAT process and allows you to keep a tidy percentage of all the VAT you collect. And that can be a big help to cash flow when money’s tight, or you’re looking for extra finance.

So, what do you need to know about VAT? And should your business register for it?

A bloke in the pub told me some VAT tricks…

VAT is complicated: VERY complicated. Let’s be clear about that.

Are you beginning to feel your head spinning?

Because the VAT rules are so complex, there’s a lot of misinformation out there about what, and how much, you can claim back from HM Revenue & Customs (HMRC).

For every bloke in the pub who’s told you about ‘my mate who claims back all his client entertainment VAT, straight up, honest!’, there’s a tax adviser who will tell you that’s nonsense (in fact, you can only claim back VAT on entertainment for your employees, not clients).

So if you’re seriously considering registering for VAT, it’s really important to do your homework and find out which scheme is going to be best for your business.

And, as you’d no doubt expect, we think the best way to do that is to come and talk to your friendly accountant and tax specialist (that’s us, by the way).

When you should register for VAT

So, when should your business register for VAT?

If your turnover hits the £85k mark, you’re legally bound to register, so it’s a good idea to keep an eye on your forecasted turnover and start planning ahead as soon as you get close to the magic £85k.

HMRC is very proactive about checking if you’re registered. HMRC inspectors will make a judgement on your turnover and can issue you a notice to provide evidence that you’re NOT over the threshold. If you’re found to be over the threshold and not registered, there are some fairly stiff penalties to pay out – so make sure you’re on the ball and register in time!

You can also get VAT registered BEFORE you reach the threshold, and there are a few key advantages of doing this, depending on whether you’re a business-to-business (B2B) or business-to-consumer (B2C) company.

As a B2B company, there are some key advantages to registering early for VAT with HMRC:

  • You improve your professional credentials in the eyes of potential clients.
  • You show you’re a serious business that can handle money sensibly.
  • You can improve your profits by making use of the different VAT schemes.
  • You can add the additional 20% to your prices and be confident that your business customers will claim back this cost in their own VAT returns.

But there also a few downsides to think about:

  • Once registered, you’re responsible for collecting VAT and paying it to HMRC.
  • You’re the custodian of that collected VAT money, and can’t spend it (however much you might be tempted to).
  • You have the extra admin workload and finance duties of managing your VAT return and making sure it’s submitted.
  • If you’re a B2C company, adding 20% in VAT to all your prices can be a shock to customers, and could make you uncompetitive.

If meeting that £85k turnover is on the horizon, or registering early sounds like a good move for the business, what do you do next?

For many smaller businesses, joining the VAT flat-rate scheme will help you to reduce the admin and actually bring in some income from your VAT collection duties.

What’s the VAT flat-rate scheme

The flat-rate scheme is HMRC’s way of making VAT simpler and more profitable for smaller businesses and start-ups.

Once your business is on the flat-rate scheme:

  • you pay a fixed rate of VAT to HM Revenue & Customs (HMRC) – rates vary depending on your industry
  • you keep the difference between what you charge your customers and pay to HMRC
  • you can’t reclaim the VAT on your purchases – except for certain capital assets over £2,000.

The real bonus of the scheme is that you get to keep the difference between what you collect in VAT (at the full rate of 20%) and what you pay to HMRC (14.5% if you’re something like an IT consultant). So, by registering, collecting VAT and paying a fixed rate to HMRC, you can potentially make a small profit on the whole process.

To keep the scheme effective, you do need to apply caution around the VATable purchases the business makes. In the example we’ve given, the flat-rate scheme will stay beneficial for your business as long as less than 27.5% (5.5%/20%) of your net expenses are standard rate VAT goods.

But if your VAT turnover meets the £150k threshold for the scheme, and your net expenses don’t go beyond the ideal threshold, it’s a no-brainer to register for the flat-rate scheme and get a tidy little boost to your income.

Accounting for the flat-rate scheme is pretty straightforward. You take your total growth income for the business, in a given time period (usually each quarter), and times that by the percentage that’s been set for your industry or sector.

So being on the flat-rate scheme removes some of the hassle of managing your VAT and makes financial sense for the business.

The VAT flat-rate schemes makes VAT simpler and also profitable.

Helping you do your VAT homework

At FD Works, we’re always looking for ways to make tax and accounting easier for small businesses. And getting you up to speed with VAT is one area where we really want to help you do your homework.

We’ve pulled together the most common VAT questions into a helpful FAQ page. Whether you’re looking to learn more about what VAT is, considering whether to register early, or searching for the best scheme for your business, we’ve got the answers.

You can dive into our VAT FAQs with the link below.

Make VAT work for your business

Get answers to all your VAT FAQs in our Help section

Get the VAT lowdown