A perennial complaint for businesses of every size is the apparently vast regulatory burden imposed by the government. The red tape through which British businesses must cut in order to comply with the relevant regulations can seem impenetrable, and many companies fall foul of them through sheer confusion. VAT registration is one area which can seem complicated and which is surrounded by sometimes burdensome regulations.
What is VAT registration?
When you pay a bill or receive an invoice, it is likely that Value Added Tax (VAT) will have been added to the subtotal. Currently set at 15 per cent, but soon to return to 17.5 per cent, VAT is a flat tax imposed on the consumer of goods or services. There are three categories that these goods and services fall into, each with its own level of VAT.
The first category, the ‘zero rate’, includes all items that do not attract a VAT liability. Most food falls within this category, with the exception of restaurant or take-away meals. Other zero rate items include books and newspapers, children’s clothing, and new home sales. The second category is the ‘reduced rate’, currently set at 5 per cent, which accounts for fuel and power used by charities and in private homes. Finally, the ‘standard rate’ of 15 per cent (set to increase again to 17.5 per cent on 1 January 2010) applies to all other goods and services.
Currently, businesses are obliged to register for VAT if they have an annual turnover of £67,000 or more. If your annual turnover is less than this, you can choose to register voluntarily.
Once you are VAT registered you will be allocated a registration number. This must be appended to all invoices and other literature in the same way as you would attach your company registration number and registered address.
Why would I register for VAT?
If your annual turnover exceeds £67,000, or if you expect it to do so within the next 30 days, you are legally obliged to register for VAT. If you fail to do so, you will be liable for a civil penalty. This will total 5 per cent of the outstanding VAT liability if you are less than 9 months late with registration, rising to 10 per cent for registration between 9 and 18 months late, and 15 per cent if you fail to register for more than 18 months.
VAT registered companies assume a considerable administrative burden. VAT must be accounted for separately and comprehensively; filing an inaccurate VAT return can result in severe penalties. Furthermore, VAT registered businesses must ensure that they set aside enough cash every quarter to pay any VAT bill that might arise. So why would any small business owner put themselves through this voluntarily?
In the first instance, VAT registration can give the impression that your business is larger than it is. If many of your clients are other businesses, they are likely to be aware of the £67,000 threshold. As such, by not registering for VAT you are giving away the fact that your turnover is below this figure.
Furthermore, while VAT registered businesses are obliged to charge VAT on any applicable products (known as output tax), they are also able to reclaim the VAT that they are charged by other businesses (known as input tax). As such, VAT registration can be a potentially profitable choice.
VAT returns are generally submitted on a quarterly basis. So, for the sake of argument, let’s suggest that you take £1,000 in VAT during this period. However, during the same period, you spend £1,000+VAT on office supplies (the VAT liability is therefore £150). In this case you will need to pay HM Revenue and Customs £850 (£1,000 minus £150). Had you not been VAT registered, you would have been £150 worse off.
But consider the downside…
Clearly, being able to reclaim all your VAT is an attractive proposition. However, it is important to remember that you will be obliged to charge VAT on all of your relevant invoices. This can have a detrimental effect on several levels. In the first instance, it could simply mean that potential customers choose a non-VAT registered competitor as their prices are lower than yours. Just as concerning is the fact that VAT registration could reduce your profit margins. It is necessary to look at some figures to illustrate this.
Imagine that you are a widget dealer. You buy widgets for £10 including VAT and you sell them on for £12. If you are VAT registered you can claim back £1.30 on each widget, increasing your profit margin from £2 to £3.30. However, now that you are VAT registered you must also charge VAT when you sell the widgets. Either you increase your prices accordingly and risk losing customers, or you absorb the VAT into your existing prices. If you choose the latter, you must pay HMRC £1.80 for every widget you sell (15 per cent of £12). As such, your profit comes back down to £1.50 - less than you would have been making had you not been VAT registered.
Furthermore, there is an additional cost associated with VAT accounting. The process of preparing and filing your quarterly VAT return can be a lengthy and therefore expensive task. If you choose to do it yourself you will be taken away from your ‘real’ work for however long it takes to complete the process. Alternatively, if you choose to employ an accountant to do it for you, you will have yet another expense to cover.
VAT registration can therefore be a difficult choice. If your turnover exceeds £67,000 it is not a choice at all - you are legally obliged to register, and will face a penalty if you fail to do so. However, if your turnover is lower than this your decision will depend on your business’s circumstances. If you deal mainly with private customers, as opposed to business clients, VAT registration may not be a sensible choice as it will either push your prices up or force you to absorb a VAT liability. However, if you have to buy a lot of supplies that attract a VAT liability, this may be offset by the savings you will make.
If you do choose to register for VAT, you must ensure that you are prepared for the new accounting burden that this will bring. It is vital that you have efficient accountancy practices, and bookkeeping software that suits your business. You should remember that not all accountancy software supports VAT accounting, and you may have to change your package accordingly.
While all this can sound daunting, it is important to remember that VAT registration can have significant benefits. If you frequently purchase goods that attract a VAT liability, and you deal primarily with other VAT registered businesses, registration can save you money - and, in some cases, mean a very welcome quarterly tax windfall.