VAT – what impact will it have on your small business?

Updated: Jul 7, 2020

Value Added Tax (VAT) is the governments way of taxing the additional value added to products and services as they make their way through the production process and to the end consumer, the general public

If you are registered for VAT - at each stage of the process you can claim VAT as it is charged to your business, and you must charge VAT on any products or services you sell You are effectively collecting the VAT on behalf of the government

The standard rate of VAT is currently 20% and payments are made either monthly, quarterly or yearly.

Here is an example:

I buy a blank notebook for £20 – I emboss my customers initials on it and sell it to them for £30

If my business is registered or VAT here is how it would work:

Sale to customer is £30 plus 20% VAT £6 = £36 total which I collect form my customer

Cost to me was £20 plus 20% VAT £4 = £24 total which I pay to my supplier

At the end of the period I then owe the government £2 (difference between the £6 collected and £4 paid). This is paid to Her Majesty’s Revenue and Customs (HMRC)

My profit remains at £10 (£30 less cost £20 both excluding VAT)

From this example we can see that: VAT is a ‘pass through’ tax – it is not intended to have a positive or negative impact on your business profit – and should have no impact on cash flow other than timing

If you are not currently VAT registered you will be paying some VAT on expenses that cannot be reclaimed – by registering you would be able to claim these back

Businesses collect VAT on behalf of the government

The end user will pay the full amount of VAT and cannot recover it – only a business that is on-selling can recover VAT

When do you need to register for VAT and book-keeping

In its simplest terms - if your turnover in the trailing 12 months is more than £85,000 you will need to register for VAT – this applies to the self employed and limited companies alike

Once registered set your accounting system to account for VAT – all UK accounting software will be able to handle VAT for you – including producing the reports that need to be electronically sent to HMRC (which is called Making Tax Digital for VAT or MTD for VAT)

Voluntary registration - you can voluntarily register for VAT and you may want to do this if for example your customers are all VAT registered, it will not impact them and you can claim back VAT on any business expenses, thus reducing your costs.

Impact on your customer

If you customer is also VAT registered there will be no impact on their costs as they will be able to claim back the VAT you have charged

If your customers are the general public, or are not registered for VAT because they are below the VAT threshold, they will have to pay the VAT without being able to claim it back from the government, hence their costs will increase

Impact in your business

There is no impact on your profit, unless

1. the increased price you need to charge (including VAT) leads to less sales, due to your customer being unable to reclaim the VAT back

2. you can claim VAT back that was not previously claimed on some business expenses

There will be increased admin costs due to keeping additional records and monthly/quarterly/yearly reporting requirements, and you will need to make sure you include all the necessary information on your invoices

Other points to note

There are a number of VAT schemes to consider including Annual, Cash Accounting and Flat Rate. Each has certain advantages for smaller businesses and should be discussed with your accountant

Additional admin will be required if you are selling abroad and particularly to an EU Member state

Landlords have the option to chose whether to apply VAT or not – so if changing your business premises you will need to check the rental agreement to understand what impact this will have on your costs. If you are VAT registered this can be reclaimed, otherwise it will be an additional cost to your business