Understanding VAT for small businesses


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The complete guide to understanding VAT returns for small businesses in the UK. Our presentation includes: VAT principles and how VAT is collected, the different types of VAT rates and categories they apply to, how VAT returns are calculated for small businesses selling exempt products, VAT registration rules and advice, the three VAT schemes explained, useful real-world examples and much more.

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Understanding VAT for small businesses

  2. 2. Understanding VAT for Small Businesses The principles • VAT stands for Value Added Tax • VAT is a form of indirect taxation • Standard rated VAT tends to be on the majority of services and products that are seen as discretionary / non-essential purchases Principles How it works for VAT registered companies • VAT is due to HMRC on certain sales (outputs) and recoverable from HMRC on certain purchases (inputs). • VAT registered entities have a duty to complete VAT returns “usually quarterly” • VAT returns now submitted online (paper returns no longer accepted) • Principle is that if output tax exceeds input tax, the business pays the excess to HMRC, but equally if input tax is less than output tax a refund is due • Standard VAT rate is 20% and is payable on most of products and services • There is also a 0% VAT rate (zero-rated) on certain items i.e. Children’s clothes • Some services are exempt e.g. insurance • Some items have a different rate e.g. 5% rate for the supply of electricity How it works for consumers
  3. 3. Understanding VAT for Small Businesses VAT bill is ultimately picked up by the consumer; But collected in stages throughout the supply chain WHOLESALER MANUFACTURER CONSUMER • Gail chops down a tree and turns it into timber • She sells it to Ollie for £400 + VAT • £400 is Gail’s income • £80 is VAT payable • Ollie turns the timber into a sofa • He sells it to Duncan for £1,000 + VAT • £1,000 is Ollie’s income • £200 is VAT payable RETAILER • Duncan runs a furniture shop • He sells it for £2,000 + VAT • £2,000 is Duncan’s income • £400 is VAT payable • The consumer pays £2,400 • Because he is not VAT registered, he can’t reclaim the tax HMRC •Paid: £80 •Reclaimed: £0 •HMRC net: £80 HMRC •Paid: £200 •Reclaimed: £80 •HMRC net: £120 HMRC •Paid: £400 •Reclaimed: £200 •HMRC net: £200 HMRC •Paid: £400 •Reclaimed: £0 •HMRC paid by retailer £400 collected in 3 stages throughout the supply chain
  4. 4. Understanding VAT for Small Businesses Quiz: Using the principle of VAT being applied to “non-essential” items, allocate these to Standard rated, Zero rated, exempt and outside the scope And the answers are… Newspapers Fruit & Vegetables Meal at a restaurant Salaries Education PAYE Cakes Biscuits Accountancy Residential rent Alcohol Water Postage stamps Charitable donations Hot food Cold food
  5. 5. Understanding VAT for Small Businesses Answers STANDARD RATED ZERO RATED EXEMPT OUTSIDE THE SCOPE Newspapers Fruit & Vegetables Cold food Biscuits Meal at a restaurant Postage stamps Salaries Accountancy PAYEResidential rent Alcohol Water Education Charitable donations taxed elsewhere So how are Zero Rated items and Exempt items treated on a VAT return? Hot food Cakes “discretionary” items “essential” items cash-like items (+ education) Trivia: In 1991 HMRC attempted to reclassify Jaffa Cakes as biscuits. They lost and thankfully Jaffa Cakes are still VAT free.
  6. 6. Understanding VAT for Small Businesses Companies that only supply VAT exempt products or services cannot reclaim VAT on their expenses Normal VAT registered business PAYS VAT ON: RECLAIMS VAT ON: EXAMPLE: • All products and services • All supplies and expenses which are standard rated • Furniture retailer handing over VAT on consumer purchases but reclaiming VAT on cost of goods sold Business that supplies VAT exempt products • Nothing • Nothing (not allowed to reclaim VAT on normal standard rated items) • Company set up sub-let residential property e.g. not VAT paid on sub-rent, but cannot reclaim VAT on normal office expenses Business that supplies both VAT exempt products and standard rated products / services • Only standard rated products / services • Purchases directly connected to standard rated products / services + an apportionment of shared expenses • Company that provides sub-let serviced accommodation with laundry and catering services • VAT only reclaimable on laundry and catering direct costs and a portion of shared VATable expenses Businesses that sell VAT exempt products can’t reclaim VAT, but those with zero rated products can
  7. 7. Understanding VAT for Small Businesses When should you register for VAT? • Entities must register for VAT if their turnover goes over £79,000When do you need to register for VAT? • Small companies that sell to consumers have a price advantage over bigger competitors because they effectively charge 20% less • Companies that provide VAT exempt supplies cannot VAT register Does it make sense to register before you need to? Are there any disadvantages or restrictions? • Registration is voluntary at any stage below £79,000 if you make standard or zero rated supplies, this is advantageous for: • Zero rated suppliers (e.g. greengrocers) as they will receive regular refunds from HMRC because their outputs will be nil • Start ups with significant VATable expenditure but with limited initial revenue (which will help ease cashflow) However, being registered for VAT, doesn’t stop certain items being “Blocked” i.e. where VAT is charged but not recoverable on your VAT return
  8. 8. Understanding VAT for Small Businesses Blocked VAT is where VAT is charged but not recoverable on your VAT return: pick out the two blocked input VAT items And the answers are… Motor Cars Telephone Client Entertaining Travel Food Legal fees Rent Computers Insurance Gas & Electricity Staff Entertaining
  9. 9. Understanding VAT for Small Businesses Blocked VAT is where VAT is charged but not recoverable on your VAT return: pick out the two blocked input VAT items Motor Cars Telephone Client Entertaining Staff Entertaining Travel Food Legal fees Rent Computers Insurance Gas & Electricity Effectively inflates the price of these types of expenses by 20% Note: In the case of leased motor cars only 50% of the VAT can be reclaimed i.e. 10% unless the car is exclusively for business use like a pool car
  10. 10. Understanding VAT for Small Businesses There are three main VAT schemes each with pros and cons • Mostly commonly used scheme • VAT declared on outputs and inputs when invoices are raised Accrual Flat rate Cash FEATURES PROs CONs • Flat rate percentage of revenue based on service/product provided • Percentage advised by HMRC is then multiplied by gross turnover. • Maximum of £150k net turnover • VAT declared on outputs and inputs when the cash is actually paid • £1.35m net sales limit • Easy to prepare by just including transaction by invoice date • Low accountancy costs • All accounting software can deal with this scheme • Need to pay VAT before cash is received • Cash flow issues e.g. if large sales invoice in period • Bad debt risk – takes at least 9 months to reclaim VAT if an invoice is never paid by a customer • Cash flow benefit as only pay VAT when it is actually paid • No bad debt risk • Time consuming to administer as VAT return requires different dates to annual accounts • Not all software supports it • VAT bills arguably more likely to fluctuate vs accrual method • Potential cash saving • Very easy to administer • Can also be prepared on cash basis • Only available to smallest businesses • Must continuously monitor costs to make sure still most cost effective scheme, e.g. if supplier starts charging VAT • Slightly more difficult to administer in terms of annual accounts Cash scheme generally better for small business; Accrual scheme generally easier for accountants! Key difference is timing of invoices
  11. 11. Understanding VAT for Small Businesses Flat Rate Scheme means that VAT is paid on Revenue at a certain percentage (determined by your industry) The flat rate of VAT is determined by industry as follows: • Accountancy 14.5% • Advertising 11% • Estate Agents 12% • Farming 6.5% • Hotels 10.5% • Pubs 6.5% In addition, you can re-claim the input VAT at the normal rate on capital items over £2,000 (gross). FLAT RATE PERCENTAGES • Technically speaking companies will benefit from the flat rate if their VATable supplies are less than: • 20% minus (20% - applicable flat rate) • Divided by 20% • Multiplied by their VATable revenue • Hotel example • 20 % - flat rate = 20% - 9.5% = 10.5% • Divided by 20% = 52.5% • Multiplied by revenue of £100k = £52.5k so in this case if the value of the Hotel’s VATable supplies are less than £52.5k, then they will save money by opting for a flat rate scheme WHEN TO OPT FOR THE FLAT RATE Generally, any business owner who suspects he or she has a lower cost structure than average should consider it (but remember the £150k limit)
  12. 12. Understanding VAT for Small Businesses VAT Flat Rate Scheme Estate Agent Worked Example Net revenue*: £120,000 Wages (40,000) Rent - exempt (15,000) Telephone* (2,400) Computer* (3,600) Travel (1,500) Accountancy* (7,200) Profit: £50,300 Note: * VATable item All figures net of VAT ESTATE AGENT EXAMPLE ACCRUAL SCHEME •VAT payable: £24,000 •VAT reclaimable: £2,640 •HMRC net: £21,360 FLAT RATE SCHEME •Net revenue: £120,000 •Gross revenue: £144,000 •VAT payable: £17,280 •Less computer: £720 •HMRC net: £16,560 £4,800 saved by flat rate scheme
  13. 13. Understanding VAT for Small Businesses Commercial property transactions can be optionally taxed Option to tax: •If supply of building/land is exempt can opt to tax •i.e. opt to treat as a taxable supply and charge VAT Implications: • Standard rated VAT will be charged on sale or lease • Input tax relating to supply may be recovered • Once made option applies for 20 years • If land/building is sold where option to tax has been made, VAT needs to be charged on sale of land/building • Construction of new commercial building • Sales of new commercial building under 3 years old • Work on existing commercial building • Sale of old commercial building (over 3 years old) • Lease of commercial building • But option to tax is available Option to tax is only useful if a landlord has significant other VATable expenses Standard rate on Commercial Buildings VAT exempt on Commercial Buildings
  14. 14. Understanding VAT for Small Businesses Summary • VAT is ultimately charged in full to the consumer, but it is collected in stages throughout the supply chain • VAT was intended to apply to all non-essential items and children’s shoes, water and certain types of food are still exempt Principles For Small Businesses Special cases • Businesses that sell VAT exempt products can’t reclaim VAT, but those with zero rated products can • VAT registration is required over £79k turnover • There are three VAT schemes: Accrual, Cash and Flat rate each with pros and cons • Owners of commercial property can opt to apply VAT if they have significant VATable operating expenses
  15. 15. Understanding VAT for Small Businesses Thanks Thank you for reading! Need further help with the preparation and completion of your VAT returns? Our team are happy to answer any of your questions. Contact Us Accounts and Legal Ltd. 20 Kentish Town Road, London, NW1 9NX 0207 043 4000 info@accountsandlegal.co.uk YOUR TEAM
  16. 16. CONFIDENTIAL This Confidential Insight Report (the “Insight Report”) has been collated by Accounts and Legal Consultants Ltd (the “Accountant”), solely for the informational purposes of the shareholders and management team of the company named on the cover sheet of this document (the “Company”) from information furnished by the management team of the Company and other public and proprietary sources. It is further agreed that the recipient of the Insight Report agrees to treat all information contained in the document as strictly confidential, being for use only by the shareholders and management team of the Company and for informational purposes only. The Insight Report does not purport to offer investment advice and may not be relied upon as such. The Insight Report may not be copied or distributed by recipients to third parties without the prior written consent of the Accountant. The information contained herein has been prepared to assist the management team and shareholders of the Company in making an assessment of the financial and operational performance of the business and does not purport to contain all the information that a management team or shareholder may need to determine the appropriate strategy for the Company. The Accountant does not make any representation or warranty (express or implied) as to the accuracy or completeness of the Insight Report or any of the information contained or referred to herein, and shall not have any liability resulting from the use of, or any omissions from, the Insight Report. The Insight Report contains certain financial data, estimates and projections and other forward-looking statements, which have been prepared based upon information provided by the management of the Company and other sources, and which involve significant assumptions, elements of subjective judgement and analysis that may or may not be correct and are subject, among other things, to business, economic and competitive uncertainties and contingencies, many of which are beyond the control of the Company. Accordingly, there can be no assurance that any of the estimated and projected results will be achieved. Actual results can be expected to vary from those set forth in or implied by such estimates, projections and other forward-looking statements, and such variations may be material and adverse. All requests for additional information should be made to: Accounts and Legal Consultants Ltd 0207 043 4000 20 Kentish Town Road London NW1 9NX