VAT compliance made easy: Essential tips for UK companies

October 10, 2024 | eBook | VAT

If you’re reading this, chances are you’ve encountered the sometimes bewildering world of Value Added Tax (VAT) and are looking for information to guide you through. You’ve come to the right place!

Whether you’re a seasoned business owner or just starting out, this guide will provide the essential knowledge and practical tips to stay VAT-compliant and avoid compliance issues with HMRC. 

We’ll cover everything from the basics of VAT to industry-specific advice, helping you to understand how VAT really works in practice. Without further ado, let’s dive in.

VAT basics – what you need to know

VAT is a consumption tax added to the cost of goods and services. It’s charged at each stage of the production and distribution process, but ultimately, the end consumer bears the cost. As a business, you’re essentially collecting this tax on behalf of HMRC.

Each business in the supply chain passes the baton (VAT) along until it reaches the final consumer. The key difference is that each business only pays HMRC the difference between the VAT they’ve collected and the VAT they’ve paid on their own purchases.

VAT rates vary

We have three main VAT rates:

1. Standard rate (20%): This applies to most goods and services. For example, if you sell office furniture, electronics, or consulting services, you’ll likely charge the standard rate.
2. Reduced rate (5%): This rate applies to some specific goods and services. For instance, it covers domestic fuel and power, making it relevant for energy companies and landlords. It also applies to mobility aids for the elderly, certain home renovation works, and some sanitary products.
3. Zero rate (0%): While no VAT is charged to the customer, you can still reclaim VAT on your purchases related to these sales. This rate applies to most food items (but not restaurant meals or takeaways), books and newspapers, and children’s clothes and shoes.

There’s also a category called ‘exempt’, which means no VAT is charged, and you can’t reclaim any VAT on related expenses. This includes things like postal services, financial transactions, and some educational and health services.

Remember, the classification of your goods or services can impact your VAT calculations and cashflow, so it’s crucial to get it right. 

If you’re unsure about which rate applies to your products or services, it’s always best to check with HMRC’s info on VAT rates or consult with VAT specialists like us at James Scott.

When to register for VAT

As of April 2024, the VAT registration threshold is £90,000. This means if your taxable turnover (that’s your total sales of goods and services that aren’t exempt from VAT) exceeds this amount in a 12-month period, you must register for VAT.

There is a twist, however. You can also choose to register voluntarily if your turnover is below the threshold. Why would you do this, you ask? Well, it could be beneficial if:

• You want to reclaim VAT on your purchases.
• You want to appear more established to other businesses.
• You’re expecting your turnover to exceed the threshold soon.

When considering voluntary registration, here are a few more points to ponder:

• If you’re making zero-rated supplies, voluntary registration could be beneficial as it allows you to reclaim VAT on your purchases without charging VAT on your sales.
• Registering for VAT could allow you to reclaim the VAT on these purchases if you’re planning significant capital expenditure.
• However, if most of your customers are not VAT-registered (like private individuals), charging VAT could make your prices less competitive.

It’s always worth doing a cost-benefit analysis or seeking professional advice before making this decision. 

Consider factors like the nature of your business, your customer base, and your future growth plans. Registering proactively and building solid VAT accounting workflows can make the transition smoother. 

VAT registration – taking the plunge

So, you’ve decided to register for VAT (or your turnover has decided for you). What now? Let’s walk through the process step by step.

Step 1: Gather your information

Before you start, make sure you have the following information handy:

• Your business details (structure, registration numbers, etc.).
• Your turnover figures.
• Bank account details.
• Details of any associated businesses.

You’ll also need:

• Your National Insurance number or Unique Taxpayer Reference (UTR).
• Certificate of incorporation or company registration number (for limited companies).
• Details of all business activities.
• Business start date or the date you went over the VAT threshold.

Having all this information ready will make the registration process much smoother.

Step 2: Choose your registration date

You can pick your registration date, but there are some rules:

• If you’ve exceeded the £90,000 threshold, you must register within 30 days.
• Your registration date is usually the first day of the second month after you go over the threshold.
• For voluntary registration, you can choose any date.

When choosing your date, consider factors like your business cycle, cashflow, and the administrative work involved in implementing VAT in your business.

Step 3: Register online

Go to the HMRC website and register online. It’s straightforward, but if you get stuck, don’t hesitate to contact us for help.

When registering online, you’ll need to provide details such as:

• Your business structure (sole trader, partnership, limited company).
• Your company registration number (if applicable).
• Details of any associated businesses.
• Your Unique Taxpayer Reference (UTR).
• Your business activity and main products or services.
• Your expected taxable turnover for the next 12 months.

The process is straightforward, but to make it as smooth as possible, ensure you have all this information ready before you start. 

If you’re unsure about any part of the form, it’s better to pause and seek advice rather than submit incorrect information.

Step 4: Wait for your VAT number

HMRC will send you a VAT registration certificate with your unique VAT number. This usually takes about 30 working days, but it can sometimes take longer, especially during busy periods.

Your VAT number is vital – once you’re registered, you’ll need to include it on all your invoices. 

Step 5: Set up your VAT account

Once you’re registered, you’ll need to set up your VAT youaccount on the HMRC website. This is where you’ll submit your VAT returns.

When setting up your VAT account, you’ll need to:

• Activate your account using the activation code sent by HMRC.
• Set up your preferred payment method.
• Choose your preferred communication method (email or letter).

Consider setting up a direct debit for VAT payments to ensure you never miss a deadline. 

Step 6: Understand Making Tax Digital (MTD) for VAT

As part of your VAT registration, it’s important to understand Making Tax Digital (MTD) for VAT. MTD is HMRC’s initiative to digitise the tax system.

Key points about MTD for VAT:

• All VAT-registered businesses are automatically enrolled in MTD for VAT.
• You don’t need to sign up separately for MTD after registering for VAT.
• You must keep digital records and use MTD-compatible software to submit your VAT returns.

To prepare for MTD:

1. Choose MTD-compatible software: Many options are available, including well-known names like Xero, QuickBooks, Sage, and FreeAgent. These software solutions help with MTD compliance and offer wider accounting and financial management features.
2. Set up your digital record-keeping: Ensure you’re keeping the required records digitally from your VAT registration date. Most MTD-compatible software will guide you through this process.
3. Train your team: Ensure anyone involved in VAT record-keeping or return submission understands the MTD requirements and how to use the chosen software.

VAT schemes – choosing the right one

Now that you’re VAT registered, it’s time to choose a VAT scheme. Different schemes suit different sizes of businesses and their respective VAT accounting demands. 

Generally, the more VAT you account for, the more compliance rules HMRC imposes to ensure you’re getting it right. 

Standard VAT accounting

This is the default scheme. You pay or reclaim the difference between VAT charged to customers and VAT paid on purchases.

Pros:

• Accurate reflection of VAT position.
• Suitable for businesses of all sizes.
• Allows for immediate reclaiming of VAT on purchases.

Cons:

• Requires detailed record-keeping.
• May lead to cashflow issues if you have to pay VAT before receiving payment from customers.

Flat Rate Scheme

Under the VAT Flat Rate Scheme, you pay a fixed rate of VAT to HMRC and keep the difference between what you charge customers and pay to HMRC.

Pros:

• Simplifies your VAT calculations.
• Can be beneficial for businesses with low expenses.
• Potentially increased profit if your flat rate is lower than your average VAT rate.

Cons:

• Not suitable for all businesses.
• You can’t reclaim VAT on purchases (with some exceptions).
• May result in paying more VAT than under standard accounting if you have high expenses.

Cash Accounting Scheme

With the VAT Cash Accounting Scheme, you account for VAT based on when you receive payment rather than when you invoice.

Pros:

• Great for cashflow.
• Useful if customers are slow to pay.
• You don’t pay VAT on bad debts.

Cons:

• Not suitable if you often reclaim more VAT than you charge.
• Only available for businesses with turnover up to £1.35 million.

Annual Accounting Scheme

The Annual VAT Accounting Scheme allows you to submit one VAT return a year instead of four.

Pros:

• Reduces admin time.
• Helps with budgeting.
• You can spread your VAT payments throughout the year.

Cons:

• You might end up overpaying VAT.
• Only available for businesses with turnover up to £1.35 million.

Choosing the right scheme depends on your business size, type, and cashflow needs. If you’re unsure, give us a shout, James Scott can help you select the best scheme for your needs. 

Mastering VAT record-keeping

While record keeping might not be the most exciting part of running a business, it’s vitally important when it comes to VAT. 

Good record-keeping isn’t just about staying on the right side of HMRC – it also makes your life easier when it’s time to file your VAT return.

What records do you need to keep?

HMRC requires you to keep records of:

• All sales and purchases.
• The VAT you’ve charged.
• The VAT you’ve paid on purchases.
• Items you can’t reclaim VAT on.
• Your VAT calculations.

Sales records should include:

• Invoices (including VAT invoices).
• Till rolls.
• Bank statements.
• Paying-in slips.
• Records of daily takings.

Purchase records should include:

• Receipts.
• Purchase invoices.
• Bank and credit card statements.
• Chequebook stubs.

You also need to keep a separate VAT account to summarise your VAT for each accounting period.

How long should you keep records?

The general rule is to keep your VAT records for at least 6 years. If you’re using the VAT MOSS service, you’ll need to keep your records for 10 years.

But why so long? HMRC can investigate your VAT affairs going back several years, so having these records on hand can save you a lot of hassle if you’re ever audited.

Digital record-keeping

As noted, with the introduction of MTD for VAT, you now need to keep digital records and submit your VAT returns using MTD-compatible software. This applies to all VAT-registered businesses, regardless of turnover.

Digital records don’t mean you need to scan every receipt. It means keeping records in a digital format that can be directly used to complete your VAT return.

Filing VAT returns 

Filing VAT returns doesn’t have to be a headache-inducing experience. The right preparation and approach can be as smooth as a well-oiled machine. Here’s how to make it happen:

When to file

Most businesses file VAT returns quarterly. Your exact due dates will depend on when you registered for VAT, but generally, you need to submit your return and payment one month and seven days after the end of your VAT period.

For example, if your VAT quarter ends on 31 March, your VAT return and payment would be due by 7 May.

It’s important to know your specific deadlines. Missing them can result in penalties, which start at £100 for a single late return.

What to include in your VAT return and how to file it

Your VAT return should include:

• Total sales and purchases.
• Amount of VAT you owe.
• Amount of VAT you can reclaim.
• What your VAT refund from HMRC is (if you’ve paid more VAT than you’ve charged).

And here’s how to file it:

1. Gather all your sales and purchase information for the VAT period. This is where good record-keeping pays off!
2. Calculate your VAT figures (your accounting software can usually do this for you). Double-check these calculations to ensure accuracy.
3. Log into your VAT online account. You’ll need your Government Gateway user ID and password.
4. Enter the figures into the VAT return form. Take care to enter the correct figures in each box.
5. Review all the information before submitting. It’s much easier to correct errors before submission than after.
6. Submit the form and make any payment due (or claim your refund). If you’re due a refund, HMRC aims to process this within 10 working days.

What happens after you submit?

After submitting your VAT return:

• Keep a copy for your records. This is crucial for future reference and in case of any HMRC inquiries.
• Ensure you have funds to pay any VAT due. Late payment can result in penalties and interest charges.
• If you’re due a refund, HMRC aims to process this within 10 days. However, they may make checks that could delay this, especially for newly registered businesses or large refunds.
• Be prepared for any follow-up questions from HMRC. They may occasionally ask for more information to verify your return.

VAT inspections

HMRC may sometimes conduct VAT inspections. While these can seem daunting, they’re usually nothing to worry about if you’ve kept good records. Here’s what to expect:

• HMRC will usually give you notice of an inspection, typically a few weeks in advance.
• They’ll want to see your VAT records and may ask questions about your business operations.
• Be cooperative and honest – it’s better to be upfront about mistakes if you’ve made mistakes.
• Have all your records easily accessible, including invoices, bank statements, and your VAT account.
• If issues are found, work with HMRC to resolve them. Honest mistakes can often be corrected without penalties if you’re cooperative.

VAT and specific industries – what you need to know

Different industries can have specific VAT rules and considerations. Let’s look at a few common sectors:

Construction

The construction industry has its own VAT reverse charge scheme for certain services. Under this scheme, the customer accounts for VAT rather than the supplier. Key points:

• Applies to specified construction services between VAT-registered businesses in the construction supply chain.
• Doesn’t apply to end-users or some intermediary suppliers.
• Affects your cashflow, as you’re no longer collecting VAT from customers on these transactions.

For example, if you’re a subcontractor providing building services to a main contractor, you wouldn’t charge VAT on your invoice. Instead, the main contractor would account for the VAT on your services in their VAT return.

Manufacturing

Manufacturers need to be aware of:

• VAT on raw materials and components: Ensure you’re reclaiming all the VAT you’re entitled to on your inputs.
• Export rules if selling internationally: Exports are usually zero-rated, but you need to keep evidence of export.
• Capital allowances on equipment purchases: While not directly a VAT issue, this can affect your overall tax position.

For instance, if you’re a furniture manufacturer, you’d charge VAT on sales to UK customers, reclaim VAT on your wood and fabric purchases, and potentially zero-rate any chairs you export to France.

Hospitality

The hospitality sector deals with various VAT rates:

• Standard rate applies to most food and drinks served for consumption on premises.
• Reduced rate for some holiday accommodation.
• Zero rate for most cold takeaway food.

For example, a cafe would charge standard-rate VAT on a sit-down meal but zero-rate VAT on a takeaway sandwich. However, a hot takeaway coffee would be standard-rated.

It’s important to have systems in place to correctly categorise sales at the point of sale to ensure the right VAT rate is applied.

eCommerce

Online retailers should consider:

• Digital services sold to EU consumers may require VAT registration in those countries or use of the One Stop Shop (OSS) scheme.
• Different VAT rules for goods shipped internationally. For example, shipments to the EU may now require import VAT to be paid.

For instance, if you’re selling e-books to customers in Germany through your own website, you may need to register for VAT in Germany or use the OSS scheme to account for German VAT.

Startups

New businesses should:

• Consider voluntary registration if expecting rapid growth. This allows you to reclaim VAT on startup costs.
• Be aware of VAT implications when seeking investment. For example, issuing shares is usually exempt from VAT.
• Understand VAT cash accounting to help with cashflow in the early stages of the business.

When you register for VAT, timing is often important. For example, a tech startup investing heavily in equipment and software development might benefit from early VAT registration to reclaim these expenses, even if it’s not making taxable sales.

Common VAT pitfalls and how to avoid them

Even the most diligent business owners can sometimes stumble when it comes to VAT. Here are some common pitfalls and how to sidestep them:

Late registration

Pitfall: Failing to register for VAT when your turnover exceeds the £90,000 threshold.

How to avoid: Monitor your turnover closely. Set up alerts in your accounting software when you’re approaching the threshold. Remember, you need to look at your turnover on a rolling 12-month basis, not just your financial year.

For example, if your turnover from January to December is £85,000, but then you have a bumper January pushing your rolling 12-month turnover to £95,000, you need to register for VAT.

Incorrect VAT rates

Pitfall: Applying the wrong VAT rate to goods or services.

How to avoid: Regularly review the VAT rates applicable to your products or services. When in doubt, check the HMRC website or consult with an accountant. Create a clear system for categorising your products or services by VAT rate.

For instance, a bookshop must apply zero-rate VAT to books, not standard-rate VAT to stationery. Having a clear coding system in their point-of-sale software can help prevent errors.

Reclaiming VAT you shouldn’t

Pitfall: Trying to reclaim VAT on exempt items or personal expenses.

How to avoid: Understand what you can and can’t reclaim VAT on. Keep business and personal expenses strictly separate. If an expense is partly business and partly personal, only reclaim the business portion.

For example, if you use your mobile phone for both business and personal calls, you should only reclaim VAT on the business percentage of your bill.

Missing the filing deadline

Pitfall: Submitting your VAT return late, which can result in penalties.

How to avoid: Set multiple reminders for VAT deadlines. Better yet, prepare your return well in advance of the due date. Consider setting up a direct debit for payments to ensure they’re always on time.

Poor record keeping

Pitfall: Incomplete or disorganised records leading to errors in VAT returns.

How to avoid: Implement a robust bookkeeping system. Consider using cloud accounting software to keep your records up-to-date and easily accessible. Regularly reconcile your VAT account with your sales and purchase records.

For instance, using software like Xero or QuickBooks can automatically categorise transactions and calculate VAT, reducing the risk of manual errors.

Ignoring VAT on employee benefits

Pitfall: Forgetting to account for VAT on certain employee benefits, like company cars.

How to avoid: Review your employee benefits package and understand the VAT implications. Include these in your VAT calculations. Remember, things like staff entertainment beyond certain limits can have VAT implications.

For instance, if you provide employees with gym memberships, you generally can’t reclaim the VAT on this cost, and you might need to account for output VAT on the benefit provided.

Your VAT compliance journey

Well done – you’ve completed our comprehensive guide to VAT compliance. We hope you’re feeling more confident about navigating the VAT landscape.

Remember, VAT compliance is an ongoing process. It requires attention to detail, good record-keeping, and staying informed about changes in legislation. But with the right approach and support, it doesn’t have to be a burden.

Key takeaways from this guide:

1. Understand your VAT obligations, including when to register and which scheme to use.
2. Keeping accurate and timely records is the foundation of good VAT management.
3. File your VAT returns on time and pay any VAT due promptly to avoid penalties.
4. Stay informed about VAT rules specific to your industry.
5. Be aware of common pitfalls and take steps to avoid them.
6. Keep up to date with changes in VAT legislation and how they might affect your business.

Do you have more questions or need more assistance? At James Scott, we’re here to help you every step of the way. 

Whether you need help choosing the right VAT scheme, preparing your returns, or dealing with a VAT inspection, our team of friendly VAT experts is just a phone call away.

Thank you for reading, and remember – we’re always here to help you make VAT easy!