The impact of VAT on small businesses: explained

VAT is one of the key tax considerations for businesses of every size. Whether you’re just starting out or already established, you need to understand the impact of VAT on your business.

VAT meaning explained

VAT, or value added tax, is a consumption tax levied in the UK and elsewhere. The amount charged in VAT is determined by the value added to goods and services at each stage of the production or distribution chain.

In the UK, the standard rate of VAT is 20 per cent. However, some things are exempt from the tax, for example property and financial transactions. Others are ‘zero-rated’, for example most food, while a small number of goods and services, for example home energy, attracts a reduced rate of five per cent.

What does VAT mean in business?

VAT is a key consideration for small businesses in the UK. Regardless of the size of your business, and even if you’re just starting out, you need to consider the impact of VAT.

There are three key ways in which VAT is likely to affect your business.

VAT registration

You are legally obliged to register for VAT if your VATable turnover exceeds £85,000 in a 12-month period. You must also register if you buy goods for more than £85,000 from VAT-registered suppliers in the EU, even if you only sell VAT-exempt goods.

However, you might also choose to register for VAT even if your turnover doesn’t reach the threshold. You might choose to do this for a number of reasons:

  • In order to give the impression that your business is larger than it is
  • In order to build trust in your business
  • In order to save money if you spend more on VAT than you take in

Charging VAT

Once you are VAT registered, you are obliged to add VAT to the cost of goods and services that are VAT taxable. You must display your VAT number on receipts and invoices.

However, you can also claim back VAT that you pay on goods and services for your business. When you come to pay your VAT bill, you will pay the difference between what you’ve taken in and what you’ve paid out.

You may also be able to backdate VAT claims for purchases made before the date of registration. You can do so for up to four years for goods that you still have, and for up to six months for services. However, these must be solely related to your business purpose.

It’s crucial that you keep proper records for VAT. These include invoices and receipts, description of use, and, for backdated claims, details of how the purchases relate to your business now.

VAT returns

Once you’re registered for VAT, you’ll need to complete regular VAT returns. You will normally do this once every three months; this is known as your accounting period.

In your VAT return you’ll record your sales and purchases, plus the amount of VAT that you owe and what you can reclaim. You’ll then see whether you are due a refund or must make a claim.

There is guidance for calculating VAT on specific items, such as cars and travel expenses. You can find the guidance here. At every stage, you must remember that you can only reclaim VAT on purchases that are made for your business purpose.

Filing and payment deadlines will be available in your online VAT account, but you’ll usually have to submit your return one month and seven days after the end of each accounting period.

You will also have to make payment on this day. You must pay HMRC electronically; cheques are no longer acceptable from most businesses.

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