UNDERSTANDING VAT FOR SMALL BUSINESSES: AUGUST 2013

Understanding VAT for Small Businesses

The principles
VAT stands for Value Added Tax VAT is a form of indirect taxation Standard rated VAT tends to be on the majority of services and products that are seen as discretionary / non-essential purchases

Principles

How it works for VAT registered companies

VAT is due to HMRC on certain sales (outputs) and recoverable from HMRC on certain purchases (inputs). VAT registered entities have a duty to complete VAT returns usually quarterly VAT returns now submitted online (paper returns no longer accepted) Principle is that if output tax exceeds input tax, the business pays the excess to HMRC, but equally if input tax is less than output tax a refund is due

How it works for consumers

Standard VAT rate is 20% and is payable on most of products and services There is also a 0% VAT rate (zero-rated) on certain items i.e. Childrens clothes Some services are exempt e.g. insurance Some items have a different rate e.g. 5% rate for the supply of electricity

Understanding VAT for Small Businesses

VAT bill is ultimately picked up by the consumer; But collected in stages throughout the supply chain
WHOLESALER Gail chops down a tree and turns it into timber She sells it to Ollie for 400 + VAT MANUFACTURER Ollie turns the timber into a sofa He sells it to Duncan for 1,000 + VAT RETAILER Duncan runs a furniture shop He sells it for 2,000 + VAT CONSUMER The consumer pays 2,400

400 is Gails income 80 is VAT payable

1,000 is Ollies income 200 is VAT payable

2,000 is Duncans income 400 is VAT payable

Because he is not VAT registered, he cant reclaim the tax HMRC Paid: 400 Reclaimed: 0 HMRC paid by retailer

HMRC Paid: Reclaimed: HMRC net:

80 0 80

HMRC Paid: 200 Reclaimed: HMRC net:

HMRC Paid: 400 80 Reclaimed: 200 120 HMRC net: 200

400 collected in 3 stages throughout the supply chain

Understanding VAT for Small Businesses

Quiz: Using the principle of VAT being applied to non-essential items, allocate these to Standard rated, Zero rated, exempt and outside the scope
Newspapers Fruit & Vegetables Education Cakes Biscuits Charitable donations

Meal at a restaurant

Salaries

PAYE

Accountancy

Hot food Alcohol

Cold food Residential rent Postage stamps

Water

And the answers are

Understanding VAT for Small Businesses

Answers

STANDARD RATED
Biscuits Meal at a restaurant Accountancy Alcohol Hot food

ZERO RATED
Newspapers Fruit & Vegetables Cold food Water Cakes

EXEMPT
Postage stamps Residential rent Education

OUTSIDE THE SCOPE

Salaries PAYE Charitable donations

discretionary items

essential items

cash-like items
(+ education)

taxed elsewhere

So how are Zero Rated items and Exempt items treated on a VAT return?

Trivia: In 1991 HMRC attempted to reclassify Jaffa Cakes as biscuits. They lost and thankfully Jaffa Cakes are still VAT free.

Understanding VAT for Small Businesses

Companies that only supply VAT exempt products or services cannot reclaim VAT on their expenses
PAYS VAT ON: All products and services RECLAIMS VAT ON: All supplies and expenses which are standard rated EXAMPLE: Furniture retailer handing over VAT on consumer purchases but reclaiming VAT on cost of goods sold

Normal VAT registered business

Business that supplies VAT exempt products

Nothing

Nothing (not allowed to reclaim VAT on normal standard rated items)

Company set up sub-let residential property e.g. not VAT paid on sub-rent, but cannot reclaim VAT on normal office expenses
Company that provides sub-let serviced accommodation with laundry and catering services VAT only reclaimable on laundry and catering direct costs and a portion of shared VATable expenses

Business that supplies both VAT exempt products and standard rated products / services

Only standard rated products / services

Purchases directly connected to standard rated products / services + an apportionment of shared expenses

Businesses that sell VAT exempt products cant reclaim VAT, but those with zero rated products can

Understanding VAT for Small Businesses

When should you register for VAT?

When do you need to register for VAT?

Entities must register for VAT if their turnover goes over 79,000

Does it make sense to register before you need to?

Registration is voluntary at any stage below 79,000 if you make standard or zero rated supplies, this is advantageous for: Zero rated suppliers (e.g. greengrocers) as they will receive regular refunds from HMRC because their outputs will be nil Start ups with significant VATable expenditure but with limited initial revenue (which will help ease cashflow) Small companies that sell to consumers have a price advantage over bigger competitors because they effectively charge 20% less Companies that provide VAT exempt supplies cannot VAT register

Are there any disadvantages or restrictions?

However, being registered for VAT, doesnt stop certain items being Blocked i.e. where VAT is charged but not recoverable on your VAT return

Understanding VAT for Small Businesses

Blocked VAT is where VAT is charged but not recoverable on your VAT return: pick out the two blocked input VAT items

Telephone Client Entertaining

Computers

Staff Entertaining

Insurance Travel Rent Gas & Electricity

Food

Legal fees
Motor Cars

And the answers are

Understanding VAT for Small Businesses

Blocked VAT is where VAT is charged but not recoverable on your VAT return: pick out the two blocked input VAT items

Telephone Client Entertaining

Computers

Staff Entertaining

Insurance Travel Rent

Food

Gas & Electricity

Legal fees
Motor Cars

Effectively inflates the price of these types of expenses by 20%

Note: In the case of leased motor cars only 50% of the VAT can be reclaimed i.e. 10% unless the car is exclusively for business use like a pool car

Understanding VAT for Small Businesses

Key difference is timing of invoices
FEATURES
Mostly commonly used scheme VAT declared on outputs and inputs when invoices are raised

There are three main VAT schemes each with pros and cons
PROs
Easy to prepare by just including transaction by invoice date Low accountancy costs All accounting software can deal with this scheme

CONs
Need to pay VAT before cash is received Cash flow issues e.g. if large sales invoice in period Bad debt risk takes at least 9 months to reclaim VAT if an invoice is never paid by a customer Time consuming to administer as VAT return requires different dates to annual accounts Not all software supports it VAT bills arguably more likely to fluctuate vs accrual method Only available to smallest businesses Must continuously monitor costs to make sure still most cost effective scheme, e.g. if supplier starts charging VAT Slightly more difficult to administer in terms of annual accounts

Accrual

Cash

VAT declared on outputs and inputs when the cash is actually paid 1.35m net sales limit

Cash flow benefit as only pay VAT when it is actually paid No bad debt risk

Flat rate

Flat rate percentage of revenue based on service/product provided Percentage advised by HMRC is then multiplied by gross turnover. Maximum of 150k net turnover

Potential cash saving Very easy to administer Can also be prepared on cash basis

Cash scheme generally better for small business; Accrual scheme generally easier for accountants!

Understanding VAT for Small Businesses

Flat Rate Scheme means that VAT is paid on Revenue at a certain percentage (determined by your industry)
FLAT RATE PERCENTAGES
The flat rate of VAT is determined by industry as follows: Accountancy 14.5% Advertising 11% Estate Agents 12% Farming 6.5% Hotels 10.5% Pubs 6.5%

WHEN TO OPT FOR THE FLAT RATE

Technically speaking companies will benefit from the flat rate if their VATable supplies are less than: 20% minus (20% - applicable flat rate) Divided by 20% Multiplied by their VATable revenue Hotel example 20 % - flat rate = 20% - 9.5% = 10.5% Divided by 20% = 52.5% Multiplied by revenue of 100k = 52.5k so in this case if the value of the Hotels VATable supplies are less than 52.5k, then they will save money by opting for a flat rate scheme

In addition, you can re-claim the input VAT at the normal rate on capital items over 2,000 (gross).

Generally, any business owner who suspects he or she has a lower cost structure than average should consider it (but remember the 150k limit)

Understanding VAT for Small Businesses

VAT Flat Rate Scheme Estate Agent Worked Example
ESTATE AGENT EXAMPLE ACCRUAL SCHEME VAT payable: 24,000 VAT reclaimable: 2,640 HMRC net: 21,360

Net revenue*: Wages Rent - exempt Telephone* Computer* Travel Accountancy* Profit: Note: * VATable item All figures net of VAT

120,000 (40,000) (15,000) (2,400) (3,600) (1,500) (7,200) 50,300

4,800 saved by flat rate scheme

FLAT RATE SCHEME Net revenue: 120,000 Gross revenue: 144,000 VAT payable: 17,280 Less computer: 720 HMRC net: 16,560

Understanding VAT for Small Businesses

Commercial property transactions can be optionally taxed

Standard rate on Commercial Buildings

Construction of new commercial building Sales of new commercial building under 3 years old Work on existing commercial building

Option to tax: If supply of building/land is exempt can opt to tax i.e. opt to treat as a taxable supply and charge VAT Implications: Standard rated VAT will be charged on sale or lease Input tax relating to supply may be recovered Once made option applies for 20 years If land/building is sold where option to tax has been made, VAT needs to be charged on sale of land/building

VAT exempt on Commercial Buildings

Sale of old commercial building (over 3 years old) Lease of commercial building But option to tax is available

Option to tax is only useful if a landlord has significant other VATable expenses

Understanding VAT for Small Businesses

Summary

Principles

VAT is ultimately charged in full to the consumer, but it is collected in stages throughout the supply chain VAT was intended to apply to all non-essential items and childrens shoes, water and certain types of food are still exempt Businesses that sell VAT exempt products cant reclaim VAT, but those with zero rated products can VAT registration is required over 79k turnover There are three VAT schemes: Accrual, Cash and Flat rate each with pros and cons Owners of commercial property can opt to apply VAT if they have significant VATable operating expenses

For Small Businesses

Special cases

Understanding VAT for Small Businesses

Thanks

YOUR TEAM

Thank you for reading! Need further help with the preparation and completion of your VAT returns? Our team are happy to answer any of your questions. Contact Us

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