What is VAT?
Value added tax (VAT) is a tax charged on the sale of goods and services in the United Kingdom. It is collected by VAT registered companies on behalf of HM Revenue & Customs.
In the UK there are currently three different rates of VAT:
- Standard rate – 20%
- Reduced rate – 5%
- Zero rate – 0%
There are also some goods and services which are VAT exempt or outside the scope of VAT. This can be confused with the zero rate, so you can understand why VAT is also referred to as Very Awkward Tax!
Each EU member state must, under EU legislation, have a standard VAT rate between 15% and 25% as well as having the option to have up to two reduced rates with a minimum of 5%. The standard rate applies to most items. The reduced rate applies to items such as domestic gas and electricity, mobility aids, women’s sanitary products, smoking cessation materials and mobility aids.
Zero rated goods and services include: children’s clothing and footwear, books and newspapers, domestic water supplies.
Exempt items include: postage stamps, medical treatment and healthcare, insurance, betting and gaming.
Click here for details of the VAT rates on different goods and services.
VAT on Food
This is a particularly confusing area and the exact definition of an item can affect whether or not VAT should be charged. The majority of foodstuffs are zero rated however ‘luxury’ items subject to the standard rate. Perhaps one of the most famous VAT case relates to Jaffa Cakes. HMRC argued that Jaffa Cakes were a luxury chocolate covered biscuit which would be subject to the standard VAT charge whereas the manufacturers, McVities, claimed they were cakes which are zero rated as so it happens are biscuits without any chocolate covering. If you don’t know McVities won the case with what happens to them when they go stale being key to the decision; Jaffa Cakes are indeed cakes despite them normally being found in the biscuit aisle at the supermarket!
Cold takeaway food is zero rated whereas hot takeaway food is standard rated. Food supplied in the course of catering is subject to the standard rate with an obvious example being a slice of cake with your coffee from a coffee shop. You will notice that the likes of Costa and Starbucks have two prices on their cakes; eating in costs you an extra 20%. Potato crisps are standard rated whilst maize and corn based snacks are such as tortilla chips are zero rated. This is a really complex area of VAT click here for guidance.
When should a business register for VAT?
The VAT registration threshold is usually set each year. Currently (2015/16) that threshold is £82,000 so any business with VAT taxable turnover over that level in a 12 month period must register. You are also obliged to register if you expect your turnover to exceed the threshold in the next 30 days or if you receive goods into the UK from the EU worth more than the £82,000 annual threshold. You must register within 30 days and if you don’t you will be liable to pay VAT from the true registration date and could also receive a penalty.
However, you don’t have to wait until you have sales at that level as you can register voluntarily and there are occasions when it is sensible to do so. Click here for more information.
What is a VAT return?
A VAT return is a form that VAT registered businesses have to file with HMRC, usually on a quarterly basis. It summarises your sales (outputs) and the amount of VAT on your sales (Output Tax) and your purchases (inputs) and the amount of VAT (Input Tax) for a particular period. The input tax is deducted from the output tax to calculate the amount of VAT you have to pay to HMRC. If your inputs are greater than your outputs then you are entitled to a refund.
When and how do I file my VAT return?
VAT returns must filed electronically (online) and any VAT due paid electronically within 1 calendar month and 7 days after the period end. Even if you have nothing to report you must still complete a return if you are due to submit one.
What happens if I submit my VAT return or payment late?
Failure to file your VAT return or make payment on time results in a default record being made against you. You may then enter a ‘surcharge period’ which lasts 12 months. If you default again during this period it is extended for a further 12 months and you may have to pay a surcharge on top of the VAT you already owe. Click here for more information about surcharges and penalties.
There are a number of VAT schemes for business owners to consider:
Standard VAT Accounting
You pay and reclaim VAT on sales and purchases based on the dates of your invoices. This means you may have to pay output VAT despite your customers not paying you, however similarly you are able to reclaim input VAT for goods and services you might not have paid for. If your customers are good payers or your takings are received at the point of sale the standard scheme can help improve cash flow. A VAT return must be submitted each quarter.
There is a current turnover limit of £1,350,000, which means this scheme is not available to all businesses. This scheme allows you to account for VAT based on payments received and made and so can help with cash flow if you have slow or poor paying customers. As with the standard scheme a VAT return must be completed each quarter. Click here for more details.
The same £1.35m turnover limit applies to the Annual Accounting scheme. As the name suggests only one VAT return is completed per year and must be filed within 2 months of the period end. Whilst only one return is completed each year businesses on the scheme make payments based on the previous year in either 9 monthly or 3 quarterly instalments. Once the annual return has been completed a balancing payment is made to HM Revenue & Customs or if applicable a refund is received. This scheme reduces admin and helps you manage your cash flow, however if your turnover falls or you regularly receive VAT refunds it is not suitable for you. Click here for more details.
Flat Rate Scheme
This scheme was developed to help small businesses with their VAT administration. Whilst you still charge VAT in the normal way the VAT return process is much simpler. Instead of deducting input VAT from output VAT businesses pay a “flat rate” percentage of their turnover as VAT. The flat rate depends on your business sector and is lower than the standard rate as it takes into account that you are not reclaiming VAT on your purchases. To be eligible for this scheme your business’ annual turnover must be less than £150,000 excluding VAT. For first year VAT registered businesses there is an additional 1% discount. There are other criteria which you must meet in order to use the scheme and you have to leave it if your turnover exceeds £230,000 (including VAT) for the previous 12 months or you expect to exceed it in the coming 12 months. Click here for more information.
This scheme was created for the retail sector. VAT is calculated as a fraction of total sales and avoids the need to issue invoices for each transaction although if a customer requests one they must be provided with one. There are 3 standard schemes with special arrangements for florists, caterers and retail pharmacies:
- point of sale
- direct calculation
Click here for more details.
The margin VAT scheme is for businesses that buy or sell second hand goods, collectables, antiques or works of art. VAT is calculated on the difference between the sales price and purchase price of an item with nothing due if no profit is made. On this scheme you pay VAT at 16.67% on the margin you make. Click here for more details.
Tour Operators Margin Scheme
Tour operators often buy goods and services from businesses in foreign countries, and cannot often reclaim their input tax. The Tour Operators’ Margin Scheme solves this problem by allowing tour operators to calculate the VAT on just the value that they add. This is a special scheme for businesses that buy-in and re-sell travel, accommodation and certain other services as a principal or undisclosed agent (that is, acting in your own name). In the UK this scheme is known by the abbreviated term ‘the TOMS’. The TOMS is a simplification measure. In many cases it enables VAT to be accounted for on travel supplies without businesses having to register and account for tax in each Member State where the services and goods are enjoyed. Click here if this scheme is of interest to you.
Need help and advice?
If you require any help or advice regarding VAT please contact your local Financial Management Centre office.
We can help you choose the right scheme and even deal with the VAT registration process for you. Once registered we can help you comply with your reporting requirements as part of our bookkeeping and VAT service.