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A beginner’s guide to business VAT

To help you get to grips with small business banking, we’ve put together an all-inclusive guide on VAT in the UK and how it affects you as a business.

7 min read

What is VAT?

VAT is a tax applied to more or less all goods and services throughout the UK. Anywhere an item or service is sold, the customer pays a standard rate tax to the government at the point of sale. 

Charged as a percentage of the overall price, it’s normally picked up at each stage in the production and distribution chain as well as during the final sale to a customer. 

What does VAT mean for small businesses? 

All businesses that provide ‘taxable’ services or goods and have a turnover that is higher than the UK threshold must register for VAT. 

In the UK, the threshold for VAT is £85,000 annually but businesses can still register for VAT if they don’t meet the threshold. As a business registered for VAT, you must charge the standard rate of 20% on all products and services, unless you fall into a reduced rate category. 

All VAT that’s charged on a product must be paid over to HMRC, but a registered business also has the ability to claim back VAT on purchases that allow them to build and market their own ‘taxable goods’. 

As a VAT-registered business, you must declare the full amount of VAT that has been charged and has been paid. This is normally done through a quarterly VAT return

Making Tax Digital

HMRC are now encouraging businesses to keep digital records of everything and provide their tax returns digitally rather than paper tax returns. It also saves you a lot of time and space in the office.

Incorrect tax returns can cost the government up to £9bn a year, so by turning everything into a digital system, there’s less chance that you’ll get your tax wrong and get a bill at the end of the tax year. 

To find out more about making tax digital and how to get set up, follow the government’s step-by-step guide.

Taxable supplies 

As a small business, you can charge VAT on ‘taxable supplies’ such as: 

  • Business sales (goods and services you sell)

  • Hiring or loaning goods to someone

  • Commission

  • Goods sold to staff 

  • Business goods used for personal reasons 

The different rates of VAT

Standard rate

Most things will fall under the 20% standard rate unless they are declared otherwise. 

Reduced rate

Items on a reduced rate generally have a VAT of just 5%. Items in this category are things like gas and electricity in the home, children’s car seats and mobility aids for the elderly. As of 15 July 2020, VAT on food, attractions and accommodation is also being reduced to 5%. 

Zero rate

Zero rate goods can still be VAT-taxable, meaning you must declare them on your VAT return but the consumer is not charged any of the tax (0%). Goods and services with a zero rate are things such as books and newspapers, children’s clothes and motorcycle helmets. 

For a full list of goods and their rates of VAT, check out HMRC’s website.

The VAT Flat Rate Scheme 

The flat rate scheme allows small businesses with a turnover of less than £150,000 to pay a fixed rate of VAT to HMRC, depending on the type of business they are. It also allows you to keep the difference between the VAT charged and the amount agreed with HMRC but does stop the ability to claim back the VAT on your purchases. 

To join the VAT Flat Rate scheme you can either join online or fill out a VAT600 FRS form (it’s not as scary as it sounds) and return it via post or email. 

You won't be able to join the scheme if you've:

  • Left the scheme in the last 12 months 

  • Committed a VAT offence, such as VAT evasion, in the last 12 months 

  • Joined a VAT group in the last 24 months 

  • Registered for VAT as a business division in the last 24 months 

  • A business closely associated with another business 

  • Joined a margin or capital goods VAT scheme 

To figure out what flat rate you should be on, check out the full list here

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How to charge VAT correctly 

If a transaction contains a good or service with standard, reduced or zero rate VAT, you must: 

  • Make sure you charge the right rate of VAT

  • Work out if it's VAT inclusive or exclusive (if a single price is shown)

  • Include VAT info on your invoice 

  • Show the transaction in your VAT account 

  • Include the amount on your VAT return 

You’ll need to make a calculation when charging VAT on goods or services, or when working out the amount of VAT you can claim back on items which were sold inclusive of VAT. 

VAT-inclusive prices

To work out a price including the standard rate of VAT (20%), multiply the price excluding VAT by 1.2. 

For example, if your business sells a jacket and the cost is £30.00, the VAT inclusive price would be £36.00 (30 x 1.2).

To work out a price including the reduced rate of VAT (5%), multiply the price excluding VAT by 1.05.

For example, if you’re charging £50.00 for a child’s car-seat the VAT-inclusive price would be £60.00 (60 x 1.05).

VAT-exclusive prices

To work out a price excluding the standard rate of VAT (20%) divide the price including VAT by 1.2.

For example, if the cost of a hoodie is £21.00, the VAT-exclusive cost would be £17.50 (21 / 1.2).

To work out a price excluding the reduced rate of VAT (5%) divide the price including VAT by 1.05.

For example, if a child’s car seat costs £55.00, the VAT-exclusive cost would be £52.38 (55 / 1.05).

You also need to make sure that you aren’t charging VAT on exempt or ‘out of scope’ goods. 

Exempt goods are things such as:

  • Insurance 

  • Postal services 

  • Health services provided by doctors 

‘Out of scope’ items are things you can’t charge or reclaim the VAT on because they fall outside of the VAT system. ‘Out of scope’ items are things like:

  • London congestion charge 

  • Items used as part of a hobby 

  • Charitable donations 

These items don’t charge any VAT but as a business you must still declare exempt items when completing your VAT return. ‘Out of scope’ items have no tax code, so wouldn’t appear on the return. Both are different to the zero rate tax bracket above. 

VAT on returned goods 

If purchased goods are returned by a customer or by you, back to the original supplier, then a replacement invoice or credit/debit note must be issued. If the goods are exchanged for something of the same value then there is no need for either of the above to be issued. 

Charging VAT on discounted and free goods 

As a business, it’s quite common to use free samples as part of your marketing or to run promotions and discounts. This brings with it a differing set of rules when it comes to VAT. Rather than try and explain it in our own words, you can access the full list of VAT charges on discounts and free goods here.

How Mettle helps small businesses with VAT

We’re always looking at ways to make things easier for you. Using Mettle invoicing, you now have the ability to add multiple VAT rates and make VAT inclusive in the price – which we calculate for you. And with our FreeAgent integration, you can calculate your tax and produce VAT returns automatically, which you can file within a single click. To learn more about our FreeAgent integration check out our blog.

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