UNDERSTANDING VAT FOR SMALL BUSINESSES: AUGUST 2013
Understanding VAT for Small Businesses The principles
Principles
How it works for VAT registered companies
How it works for consumers
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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
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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
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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. Children’s 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
MANUFACTURER
RETAILER
CONSUMER
• Gail chops down a tree and turns it into timber • She sells it to Ollie for £400 + VAT
• Ollie turns the timber into a sofa • He sells it to Duncan for £1,000 + VAT
• Duncan runs a furniture shop • He sells it for £2,000 + VAT
• The consumer pays £2,400
• £400 is Gail’s income • £80 is VAT payable
• £1,000 is Ollie’s income • £200 is VAT payable
• £2,000 is Duncan’s income • £400 is VAT payable
• Because he is not VAT registered, he can’t reclaim the tax
HMRC •Paid: £80 •Reclaimed: •HMRC net:
HMRC •Paid: £200 •Reclaimed: •HMRC net:
£0 £80
HMRC •Paid: £400 • £80 Reclaimed: £200 £120 •HMRC net: £200
£400 collected in 3 stages throughout the supply chain
HMRC •Paid: £400 •Reclaimed: £0 •HMRC paid by retailer
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 Cakes
Newspapers Fruit & Vegetables
Meal at a restaurant
Biscuits Education
Charitable donations
PAYE
Salaries
Accountancy
Cold food
Hot food Alcohol Water
Residential rent Postage stamps
And the answers are…
Understanding VAT for Small Businesses Answers
STANDARD RATED
ZERO RATED
EXEMPT
Biscuits
Newspapers
Postage stamps
Salaries
Meal at a restaurant
Fruit & Vegetables
Residential rent
PAYE
Accountancy
Cold food
Education
Charitable donations
Alcohol
Water
Hot food
Cakes
“discretionary” items
“essential” items
cash-like items
OUTSIDE THE SCOPE
taxed elsewhere
(+ education)
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:
Normal VAT registered business
Business that supplies VAT exempt products
Business that supplies both VAT exempt products and standard rated products / services
RECLAIMS VAT ON:
EXAMPLE:
• All products and services
• All supplies and expenses which are standard rated
• Furniture retailer handing over VAT on consumer purchases but reclaiming VAT on cost of goods sold
• 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
• Only standard rated products / services
• Purchases directly connected to standard rated products / services + an apportionment of shared 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
Businesses that sell VAT exempt products can’t 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?
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Entities must register for VAT if their turnover goes over £79,000
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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)
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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
Does it make sense to register before you need to?
Are there any disadvantages or restrictions?
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However, being registered for VAT, doesn’t 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
Staff Entertaining
Computers
Insurance Travel
Food Rent
Gas & Electricity 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
Staff Entertaining
Computers
Insurance Travel
Food Rent
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 There are three main VAT schemes each with pros and cons
Key difference is timing of invoices FEATURES
Accrual
Cash
Flat rate
PROs
CONs
• Mostly commonly used scheme • VAT declared on outputs and inputs when invoices are raised
• Easy to prepare by just including transaction by invoice date • Low accountancy costs • All accounting software can deal with this scheme
• 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
• 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
• 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
• 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
• 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
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% In addition, you can re-claim the input VAT at the normal rate on capital items over £2,000 (gross).
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
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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 Hotel’s VATable supplies are less than £52.5k, then they will save money by opting for a flat rate scheme
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
Net revenue*:
£120,000
Wages Rent - exempt Telephone* Computer* Travel Accountancy*
(40,000) (15,000) (2,400) (3,600) (1,500) (7,200)
Profit:
£50,300
Note: * VATable item All figures net of VAT
ACCRUAL SCHEME •VAT payable: £24,000 •VAT reclaimable: £2,640 •HMRC net: £21,360
£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
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• VAT exempt on Commercial Buildings
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Construction of new commercial building Sales of new commercial building under 3 years old Work on existing commercial building
Sale of old commercial building (over 3 years old) Lease of commercial building But option to tax is available
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
Option to tax is only useful if a landlord has significant other VATable expenses
Understanding VAT for Small Businesses Summary
• Principles
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• For Small Businesses
Special cases
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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 children’s shoes, water and certain types of food are still exempt Businesses that sell VAT exempt products can’t 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
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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