What is Value-Added Tax (VAT) and how Does it Work?
Most people will have heard of Value-Added Tax (VAT). What people may not know is that a third of all government revenue comes from this sales tax. It affects not just companies, but every one of us with many of the purchases we make (both online and on our shopping street). Despite its importance, VAT remains one of the least understood taxes. For the high street consumer, VAT becomes part of the purchase price and we often don't even think about it. However, companies have a different attitude towards VAT. For businesses, VAT is often not profitable, but it is an important part of their business, and incorrect accounting can create serious problems. This guide is therefore aimed at businesses rather than the general consumer.
What is VAT?
Value-Added Tax is an acronym for Value Added Tax and was introduced in the United Kingdom in 1973. It is a tax that is applied on the purchase price of certain goods, services, and other taxable supplies bought and sold in the UK. There are 3 rates of VAT in the UK and each rate depends on the goods or services supplied.
What is the VAT Threshold?
You must register for VAT if your taxable sales exceed £ 85,000. Sales, where the VAT rate is zero, are also deemed to be taxable sales. Companies that do not exceed this threshold do not have to collect VAT on the sale of their goods or services and do not have to register with HM Revenue & Customs (HMRC). If a company has sales above the threshold, it must contact HMRC and register for Value-Added Tax. This turnover threshold is measured in a rolling 12-month period and not in a fixed period such as the tax year or the calendar year. Therefore, it can be any period of 12 whole months, for example from the beginning of June to the end of May. For unregistered companies with sales close to the registration limit, it is important to keep a close eye on this regularly, as there are strict deadlines for filing the registration and collecting sales tax once the sales threshold is exceeded.
Registration for VAT
In this context, VAT applies equally to every corporate structure, including companies, partnerships, and sole proprietorships. Upon registration, HMRC will issue a VAT registration certificate confirming the company's VAT identification number, the effective date of registration, and the due date of the first VAT return. It should be noted that any company with sales below the threshold can opt for VAT registration, this is known as voluntary registration. Voluntary VAT registration can have benefits.
Accounting for VAT
Once registered, a company must report the appropriate Value-Added Tax rate on all of its taxable sales. This is known as an exit tax. VAT is ultimately paid by their customers, but it is the company's responsibility to report it to HMRC and pay it. Businesses can also typically reclaim the VAT paid on business-related purchases, known as input tax. However, some items are not eligible for a VAT refund, Maintenance expenses, cars, and (for partnerships) purchases for personal use.
How to Calculate Sales Tax
Calculating VAT is pretty easy. To find the prices including Value-Added Tax, simply multiply the price plus VAT by 1.2, which adds the usual VAT rate of 20% to the price. For the reduced VAT rate of 5%, simply multiply the price (excluding VAT) by 1.05. To calculate prices excluding VAT, simply divide the total price (including VAT) by 1.2 for the standard rate (20%) or by 1.05 for the reduced rate (5%).
What is a VAT Return?
Companies registered for Value-Added Tax must report the amount of output and input tax to the HMRC using a VAT return. This is usually completed quarterly. Most vats registered businesses with sales above £ 85,000 are also required to adhere to the Digital Tax Administration (MTD) rules for VAT, introduced in April 2019.
What is my VAT Number?
A sales tax identification number, also known as a sales tax identification number, is a unique code that is assigned to a company registered for sales tax. This number has 9 digits and is usually displayed with GB at the beginning. HMRC issues a VAT registration certificate to a company on which the company can find its VAT registration number. Your VAT number must be checked on every VAT return. Errors in your VAT return can lead to delays, while HMRC can reject your tax receipt application.
How to Check if a Company is VAT Registered?
You can check if a UK company is Value-Added Tax registered by using a service on the UK government website. This service allows you to verify that a VAT number is valid, and you can also look up the company name and address to which the number is registered. It can also be used to record when you've verified a UK VAT number.
The VAT registration is required by law, failure to comply with these rules can lead to significant fines and, in the worst case, to imprisonment. The late registration penalty imposed by HMRC is calculated as a percentage of VAT owed (input tax less input tax) from the date a business should have registered to the date either HMRC receives your notice or in full became aware of it you were notifiable. The amount of the fine depends on how late you were to register. HMRC can also charge surcharges if they do not receive the VAT return or full payment of the VAT due in due time. These surcharges can amount to up to 15% of the VAT outstanding on the due date. You are also empowered to impose penalties of up to 100% for under or over-tax claims if a company sends a statement containing a negligent or willful inaccuracy.
How can I reclaim VAT?
You may be able to claim the VAT back on goods and services that are solely used by your business, such as computers, office furniture, transportation costs, and third-party costs (e.g. accountants). You cannot reclaim VAT on goods and services intended for personal use, nor can you reclaim VAT on business entertainment expenses. To reclaim VAT, a quarterly VAT return must be completed. This requires you to calculate the difference between the amount of sales tax your company paid and the sales tax the company charged during a billing cycle. The VAT refund process is not straightforward, and there are many exceptions, exemptions, and reservations that need to be considered. We therefore strongly recommend discussing your requirements with a qualified business tax expert.