Value Added Tax (VAT), perhaps more than any other UK tax, seems to cause much confusion and misunderstanding, particularly among smaller businesses who don't have the resources to keep in-house expertise! So I thought I would write a very brief introduction to the tax and explain a bit about the framework within which VAT operates in the UK. I hope a few readers might find it helpful!
What is VAT?
The VAT Act defines VAT as a tax on supplies of goods or services (apart from specifically VAT exempt items) made in the UK by a taxable person "in the course or furtherance" of a business. This means that:
- there needs to be a "taxable person" - someone who is required under the VAT Act to be VAT registered. A taxable person need not be an individual - it could be, for example, a partnership, a company or a trust;
- VAT is chargeable by that person on the supply of goods or services (except on items which are VAT exempt);
- VAT is applicable only to supplies that are made (or deemed to be made) in the UK;
- the tax applies only to supplies which are made in the course of a business; so there needs to be a business. The basic test here is whether supplies are being made in return for some form of consideration (money or money's worth).
VAT rates and exemptions
As mentioned above, the supply of certain types of goods and services is VAT exempt. These items are listed in Schedule 9 to the VAT Act.
The supply of certain other items is subject to VAT at the zero rate (Schedule 8) or the reduced rate (Schedule 7A), currently 5%.
All other supplies made in the UK by a taxable person in the course or furtherance of a business are subject to VAT at the standard rate, currently 20%. There is no list of standard rated items (it would, after all, be a very long list!).
VAT registration is usually mandatory where the value of taxable supplies made in the UK in the course of a business exceeds the VAT registration threshold in any twelve month period (unless the breach is temporary); or where the value of taxable supplies is expected to exceed the registration threshold in the next thirty days alone. At the time of writing, the VAT registration threshold is £85,000.
Failing to register for VAT on time is, unfortunately, a fairly common occurrence. Traders may not understand how the registration tests work; or may not realise that penalties can apply if HMRC is not notified within specified timescales. In the case of the rolling twelve month test, HMRC should be notified within thirty days of the end of the period in which the registration threshold is exceeded. Many traders think that the registration test is based on the turnover shown in the annual accounts; this is not the case.
Traders may register for VAT voluntarily where taxable supplies do not exceed the threshold, as long as some level of taxable supplies is made, or intended to be made. Voluntary registration is common not only where the trader's taxable supplies are approaching the registration threshold, but also in many other circumstances. Voluntary registration is often attractive to the startup business that expects to incur a lot of purchase VAT during the early days of operation.
Registering for VAT may also offer traders the prospect of recovering purchase VAT that has previously been incurred on goods and services acquired for the purpose of the trade, subject to the detailed rules on "pre-registration VAT".
Returns and record keeping
VAT registered traders are subject to detailed requirements concerning record keeping, the format of documents, filing returns and paying the VAT due. A detailed discussion is beyond the scope of this article; suffice to say that those who are registered need to have a sound grasp of the requirements, as HMRC has extensive powers to apply financial penalties for non-compliance!
A variety of special schemes exist which modify or simplify the VAT rules in some circumstances; there are special schemes for farmers, retailers, and various other groups of traders. The Flat Rate Scheme has been a popular choice for consultancy type businesses over the years, although recent measures imposed by the Government have considerably lessened the attractiveness of this particular scheme.
Traders tending to have more complex VAT affairs
Traders involved in the construction industry; those who make a mixture of taxable and exempt supplies; those buying from or selling to countries other than the UK; and charities (who in many instances undertake a mixture of business and non-business activities) often have particularly complex VAT affairs and may, in consequence, require specialist assistance.
I was a bit alarmed to read recently that Phillip Hammond is considering reducing the UK VAT registration threshold to around £20,000. The UK has one of the highest registration thresholds in Europe, so a reduction of some sort would not be entirely unexpected. Yet if hundreds of thousands of smaller businesses were suddenly brought into the regime, there would surely be many significant (and perhaps unexpected) consequences. Would HMRC cope with the extra workload? What impact would this have on productivity? On inflation? Personally I don't think it will happen... but then few people expected the tax hike on dividends, or the interest relief restriction applicable to private landlords. So it could happen. Watch this space!
Further details and conclusion
For a more detailed overview, HMRC's VAT Notice 700 The VAT Guide is quite good, though as it is HMRC's view of the world, it must therefore be treated with a degree of caution!
I will close with the standard caveat: as is to be expected, VAT, like all UK taxes, is a very complex subject and I have only touched on a few of the basics in this article. Nothing in this article should be construed as advice. If you require assistance on VAT matters, give us a call.