VAT schemes explained and how to choose the right one for your business

What is VAT?

Value Added Tax (VAT) is a tax that businesses charge on the products and services they offer. The tax amount is based on the cost of the item and is a percentage of the cost. This means that the more expensive the product or service, the higher the VAT.

Different VAT rates

Once you have determined that your business must charge VAT, you will need to identify what of the three rates of VAT applies to your business: 

• Standard rate: the most common rate is 20% that the majority of businesses charge and pay 
• Reduced rate: this applies depending on the nature of the sale and the product. For example, children’s car seats and domestic power are charged at 5% VAT. If you think you should be paying a reduced rate you should get in touch with HMRC
• Zero rate: products and services that fall under this category will still be VAT-taxable but the rate of VAT is 0%. This category includes the sale of dinnated goods, utility, newspapers and more.

What is the threshold for registering for vat?

If a business's yearly profits from selling goods and services exceed a certain amount set by the government, known as the VAT threshold, that business is required to register for VAT with the HMRC and charge VAT on their taxable goods and services. The VAT threshold for the 2021/22 tax year is £85,000.

This means that any business with a taxable turnover over £85,000 must also set aside VAT, account for it on their tax returns, and pay VAT back to the government. If a business fails to register for VAT when they reach the threshold, it may face penalties and investigations.

You have the option of registering for VAT if your annual turnover is less than £85,000, even though it is not required by law. This is known as "voluntary registration."

If you are thinking of voluntary registration, see the benefits and drawbacks below.

Benefits of registering your business for VAT

• If you are VAT registered you reclaim any cost on purchases that include VAT which reduces your cost of sales, resulting in higher profits.
• Being VAT registers can also give the impression that you are a more established business which can be a positive signal to customers, suppliers and other stakeholders.
• Selling to other VAT-registered businesses will mean that the additional VAT on the invoice will not be an issue as the other business can reclaim this.

Drawbacks of registering your business for VAT

• Registering for VAT automatically brings on more burden and administrative responsibility.
• If you have to add VAT to the price of your goods and services it can reduce the competitiveness of your business and if you absorb this cost it will reduce your profits.
• If you fail to pay or submit your VAT on time you risk penalties from HMRC.

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What are the different VAT schemes?

There are several different VAT schemes that can be used, depending on the specific needs and circumstances of the business.

Below are the common VAT schemes explained.

VAT Annual Accounting Scheme

The annual accounting scheme is available to businesses with a taxable turnover of less than £1.35 million per year. Under this scheme, businesses only make one VAT return which is due 2 months after their year end. Throughout the year businesses can make nine or three equal payments of VAT throughout the year, based on their estimated VAT liability (last year's total VAT). Any difference at the end of the year is then settled 2 months after the end of your accounting period based on the actual VAT liability.

VAT Cash Accounting Scheme

This scheme is available to businesses who forecast their taxable turnover to be under £1.35 million during the next 12 months. Under this scheme, businesses only pay VAT when they actually receive payment for their sales and can only claim back VAT when they have paid for their purchases.

This means there is no requirement to pay VAT on credit sales which eliminates the cash flow cost of VAT on bad debts.

VAT Flat Rate Scheme

The flat rate scheme is available to small businesses with a taxable turnover of less than £150,000 per year. Under this scheme, businesses charge normal VAT on all invoices to customers but only hand over a fixed percentage back to the government.

The fixed-rate depends on the industry and can range from 2% in you are a limited-cost business to 14.5% if you run an accountancy practice, IT consultancy or surveyor. Under the flat rate scheme, there is no requirement to document the cost of the input VAT (VAT on purchased goods or services for your business)

VAT Margin Schemes

A VAT Margin scheme allows you to calculate and pay VAT of 16.67% on the difference between what you sold the time for and how much you paid for it. This scheme is only available for businesses selling second-hand goods, works of art, antiques, or collectors' items but not precious stones, metals, gold or items on which you paid input VAT.

VAT Retail Schemes

A retail scheme would help to simplify the VAT for businesses selling low-value or small-quantity items.

There are three VAT retail schemes depending on your business and its needs.

• Point of Sale Scheme
• Apportionment Scheme
• Direct Calculation Scheme

In conclusion, it is important for businesses to understand the different VAT schemes available and to choose the one that best fits their needs. It is essential to carefully consider the pros and cons of each option and to seek professional advice if necessary to ensure that the chosen VAT scheme is the most appropriate for the business.