Editor | 19 January 2021
VAT: An introduction for small businesses

VAT: An introduction for small businesses

Registering for VAT can feel scary for businesses, but it is an essential part of growth. In this brief introduction to the tax, we give you all the most important information to help you grow more comfortable with the tax.

What is VAT?

VAT or Value Added Tax is a tax that’s applied to most goods or services. It’s paid by businesses and individuals, but not every business needs to charge VAT.

VAT is collected on Sales invoices and paid on purchase invoices with the net amount collected being paid across to HMRC after completion and submission of a VAT return. 

How does VAT work?

Sole traders, limited companies and other businesses need to register for and charge VAT if their turnover exceeds £85,000 in a 12-month period. If you think your turnover will exceed £85,000 in the next 30 days, you need to register your business for VAT immediately.

Businesses must charge the standard rate of VAT (20%) on most goods and services. Some goods and services are subject to VAT at a discounted rate of 5%, while some products and services are exempt from VAT, including most food, children’s clothing, financial services and insurance.

You can see the full breakdown of VAT rates and the various schemes on the gov.uk website.

What is Making Tax Digital for VAT?

Making Tax Digital for VAT is the first step in the government’s tax digitisation programme. Introduced in 2019, it means that all VAT-registered businesses in the UK need to file VAT returns using HMRC-approved software like FreeAgent or Xero.

How do I charge VAT?

There are a number of different VAT schemes that businesses can use to charge and pay VAT. It’s important you discuss which type of VAT scheme is the most appropriate for your business.

The most common types of VAT scheme are:

Standard accounting

This is the standard VAT scheme. On a quarterly basis, the difference between VAT on Sales invoices and VAT on purchase invoices is paid to HMRC. These figures are reported even if the invoices have not been paid.

Cash accounting

As an alternative to standard accounting, for businesses with a turnover below £1.35 million per year, cash accounting means that the VAT amount payable to HMRC is based only on invoices that have been paid.

Flat rate VAT

The Flat rate VAT is scheme is only for businesses with a turnover of £150,000 per year or less and is popular with small businesses and sole traders. You still charge the standard VAT rates on your Sales however you pay a lower fixed rate of VAT to HMRC. The rate depends on the type of business and does come with some restrictions including that you cannot reclaim VAT on purchases except for certain capital items over £2,000. 

To learn more about small business VAT or for advice on which type of VAT is best for your business, speak to a member of the team today. Call: 0800 281 0303.  

Download the VAT GUIDE - An introduction for small businesses

Download the EU VAT Explained Guide