Understanding your VAT liabilities can be a challenge for small businesses. If you need to register for VAT, there's a choice of schemes available, and you'll need to understand which is best for you.
What's more, it can be even more complex for trade businesses as they may come across several different rates of tax within the same project, which is less common in other industries.
Here's a rundown of VAT issues for trade and service businesses.
What is VAT?
"Value Added Tax" or VAT is a tax which all VAT-registered small businesses have to add to their sales invoices.
All businesses, from sole traders to partnerships and limited companies, must register for VAT once their last 12 months' sales go over the VAT threshold, currently £85,000. They must also file a quarterly VAT return and make quarterly payments to HMRC.
The business must pay the VAT they charge to HMRC, but they can offset any VAT they pay out to their suppliers.
For example, if a business charges £15,000 + VAT for a construction job, this means a bill of £18,000 to the customer. The extra £3,000 must be paid to HMRC. But if the business had bought £9,000 of supplies, breaking down as £7,500 (base cost) + £1,500 VAT, they can offset this. In other words, they can deduct that £1,500 from the £3,000, meaning they only owe £1,500.
A non-VAT-registered business would not need to charge VAT to their customers, and neither would they be able to claim back any paid to suppliers. In the above example, if the business were not VAT-registered they would not need to pay £1,500 to HMRC at all. They would therefore be able to pass this saving on to the customer by charging them £16,500 (instead of the VAT-inclusive price of £18,000), while still making the same profit.
As the consumer is seeing a lower bill, this amounts to a competitive advantage for the business - as well as avoiding the additional work and hassle of keeping VAT records and filing returns.
What VAT rate should trade businesses use?
Most trade work is charged at the standard rate of 20%. However, there are quite a few exceptions, and trades and construction generally have the most complex rules relating to VAT:
- new builds are usually zero-rated - ie no VAT is payable;
- some conversions and refurbishments attract a reduced rate of 5%;
- also attracting lower rates are installations of anything related to energy saving or people's disabilities.
Understanding the lower rates gives a competitive advantage if the other guys can't work it out and charge 20%. It is complicated, though, and until you are clear on the rules it's worth speaking to an accountant.
Choosing your VAT scheme
Normally, businesses submit a VAT return once every three months, and this is based on the sales and supplier invoices raised or received in that three-month period. It doesn't matter if they have been paid or not.
Other schemes include the cash accounting scheme, which means that only paid invoices (sales or supplier) are included in the quarterly return. This can work well if you receive quick payment for sales invoices. You can choose to join this scheme, as long as your sales are less than £1,350,000.00.
Another alternative is the "flat rate scheme", which allows you to calculate VAT due to HMRC as a percentage of your turnover, rather than the difference between the actual VAT you have charged and paid. You will only be eligible if your estimated taxable turnover in the next year is below £150,000.
How to avoid becoming VAT-registered
You might think you could avoid VAT hassle by running different companies and spreading your jobs across them - so that you don't reach the registration threshold for any one business.
Unfortunately, there are strict rules against this - and if you are caught doing it (or failing to register for VAT when you should), there will be nasty consequences.
However, if you're approaching the VAT threshold and want to avoid going over it, you may be able to ask customers to pay directly for materials. You can even buy them yourself using "disbursements", so that only your labour charges will count towards the VAT threshold.
There are strict rules you must follow if you want to do this. Always work with an accountant to make sure you stay within the rules and avoid penalties.
A quick disclaimer
This blog has provided an overview of VAT for trade businesses and will help you understand which questions you need to ask. It's important to declare that I am not an accountant myself, although I have spoken to one to check this advice is correct.
As your business grows, making sure you check things out with a competent accountant will almost always saves a lot more than it will cost. All the best in navigating these shark-infested waters!
Copyright © 2017 Benjamin Dyer, co-founder and ceo of Powered Now Invoicing App, helping tradespeople to simplify paperwork and save time.