The VAT minefield: Taking the plunge

The VAT Minefield – Advantages and Disadvantages of VAT Registration for Small and Medium Sized Businesses.

Value Added Tax (VAT) is part of the cost of most purchases that you’ll make as an individual or a business within the UK. Registering for VAT offers a number of benefits to the SME but also carries a few costs that it’s important to be aware of. This blog deals with some of the issues around VAT registration for companies of various sizes.

It’s important to say at the outset that if your business, club, society or organisation turns over more than the threshold amount across a rolling twelve-month period, then you must register; failure to do so will usually result in substantial fines. Thresholds are variable for different types of business activity. At the time of writing, £81,000 is the limit for most businesses. For companies involved in distance selling (delivering goods from another EU country to companies in the UK who are not VAT registered) there’s a lower limit of £70,000 and under the Simplified EC Sales List, if you’re making supplies to VAT registered companies elsewhere in the EU, there’s a turnover limit of £72,500 + £11,000 of additional supplies to those companies. If your turnover (over a rolling twelve-month period, remember, not a calendar year) is less than the threshold for your type of business, you don’t have to register, but you might choose to voluntarily.

Costs and Benefits of Registration

The decision to voluntarily register for VAT has a number of implications for smaller businesses. The first and most important of these is that as a VAT registered business you must charge VAT on all your sales at the appropriate rate (see below). This means that the moment your registration is complete, the cost of your products to your customers will go up by (usually) 20%. Either that, or the costs you absorb will increase by the same percentage.

Here’s an example:

Let’s say you’re selling deluxe paperclips that cost you £14 a box wholesale, for a £20 box exclusive of VAT. Once you register, you’ll have to pay VAT at the standard rate of 20% to HMRC for every sale. You could raise your prices (perhaps each box will now cost £25), leaving you with the same margin (£6), or absorb the cost yourself, maintaining the retail price at £20 and making only £2 profit before income and corporation tax.

Seems like a nightmare doesn’t it? And bearing in mind that a higher price is likely to drive away some customers too, what possible benefits could there be in registering voluntarily? There are a few.

The most important advantage to VAT registration is that you’ll be able to claim back VAT on any items that you purchase in relation to the sale of VAT eligible goods (see below). That includes not only the products or raw materials themselves (your original box of paperclips now costs you only £11.20 if the supplier is charging VAT), but also any goods or services that you buy in relation to the sale of those items; petrol for distribution, for example. This also applies to any of your customers who are VAT registered; they won’t care if you raise your prices to incorporate VAT because they can just claim it back in the next VAT period.

A further fringe benefit of registration comes from the fact that if your business isn’t VAT registered, all your customers and competitors will know that your turnover is less than £81,000. If you’re cultivating an image as a large, well-established and successful company, this could be a problem. Registration might do nothing for your turnover, but it will hide a piece of information that might otherwise affect you adversely.

So what should I do?!

The bottom line is, if the majority of your suppliers and customers are VAT registered, and most of your products are eligible for VAT (see below), there’s almost certainly a benefit to you in registering. You’ll be able to reduce your purchasing costs and offset the larger tax bill you’ll incur by raising your prices. Providing your customers are also VAT registered, they won’t mind the increase – they’re going to claim it back anyway.

The problems start if a significant proportion of your customers are not able to reclaim VAT. They may not tolerate an increase in price, and may go elsewhere. If your suppliers are VAT registered, particularly if your products require the purchase of lots of extra goods and services during manufacture, design or distribution, you may be able to absorb the extra tax bill and still make more money through a reduction in costs, but (then again) you may not. This is the kind of situation in which it’s best to get the advice of a qualified individual, like an accountant.

One thing that’s definitely not a good reason to avoid registering for VAT is that there’s ‘too much paperwork’. That, nowadays is frankly just not true. Not only can you get an accountant to manage your VAT return (and often save you money in the process) but there are a large number of cloud-based accounting applications that can take a huge amount of the burden.

More about VAT

Three principle rates of VAT must be charged on all products sold by VAT registered companies: 20% (standard) 5% (reduced) and 0% (zero). Some items are also exempt from VAT and although they might seem to amount to the same thing as 0%, there is an important difference between them. Zero-rated goods are still taxable for VAT, it’s just charged at 0%. Companies selling these goods and services are therefore able to reclaim VAT on any purchases they make that relate to these items – packing machinery or material, for example. Exempt items, by contrast, are not taxable for VAT and as such, no VAT can be reclaimed in relation to activities involved in selling them. Zero rated goods must be included in your VAT return and accounted for by HMRC; exempt goods and services do not need to be included. Before taking the decision to register for VAT, it’s a good idea to know the rate of VAT you’d have to pay, not just to HMRC, but also to your suppliers.

In short, taking the decision to register for VAT is a key one in the life of a company. It’s a complicated system and there are lots of factors to consider before taking the plunge. The safe option is to wait until you have no choice (that is, your turnover exceeds the threshold), but it’s also the case that without VAT registration, many businesses won’t get there, or at least will take a number of years to do so. Like all decisions of this kind, if you possibly can, it’s a good idea to enlist the help of an independent and experienced expert to advise you.

Pointers

  • If your business, club, society or organisation turns over more than the threshold amount (around £81,000 for most businesses) across a rolling twelve-month period, then you must register for VAT
  • You can also choose to become VAT registered, and you must then charge VAT on all your sales
  • This usually means that the cost of your products to your customers will go up by 20 per cent, or you will have to absorb the cost yourself
  • There are three principle rates of VAT: 20 per cent (standard) 5 per cent (reduced) and 0 per cent (zero). Some items are also VAT exempt
  • The main benefit of registering is that you’ll be able to claim back VAT on any items that you purchase in relation to the sale of VAT eligible goods
  • That includes not only the products or raw materials but also any goods or services that you buy in relation to the sale of those items
  • If the majority of your suppliers and customers are VAT registered, and most of your products are eligible for VAT, there’s almost certainly a benefit in registering
  • You’ll be able to reduce your purchasing costs and offset the larger tax bill you’ll incur by raising your prices. Providing your customers are also VAT registered, they can claim it back anyway
  • It’s best to get advice from a qualified individual such as an accountant when deciding whether to become a VAT registered business
  • Don’t be put off by the paperwork – you can get an accountant to manage your VAT return or there are cloud-based accounting applications that can help

Apr 14, 2015