Guides

Value Added Tax (VAT) is charged on the supply of goods and services in the UK and on the import of goods and certain services into the UK.

Special rules are applied to transactions within the European Union (EU), these are outlined below.

There are a number of schemes available to simplify VAT administration.

All supplies of goods and services to UK and overseas customers are taxable supplies, apart from items which are specifically exempt (see below). Goods taken for own use are also classified as taxable supplies valued at cost.

Business gifts are taxable supplies except where the gift is valued at £50 or less and does not form part of a series of gifts to the same person. These gifts would be valued at cost. Vat is not normally charged on gifts of services.

There are currently three VAT rates, a standard rate of 17.5%, a zero rate, and a reduced rate of 5%.

Businesses with a taxable VAT exclusive annual taxable turnover of up to £150,000 and whose total VAT exclusive turnover (including the value of exempt and non taxable income) does not exceed £187,500 can join the flat rate scheme. (subject to certain exclusions , such as those using the second hand or capital goods scheme, those convicted of VAT offences and group companies).

Instead of calculating input and output VAT those using the scheme calculate the VAT payable by applying the appropriate flat rate for their trade sector to the VAT inclusive value of their business supplies in the period including reduced rate, zero rate and exempt supplies.

Supplies are invoiced in the normal way showing the normal VAT rate.

The business retains any VAT charged to its customers but does not make a separate claim for input tax charged as this is covered by the flat rate.

If the business acquires capital goods in the period with a tax inclusive value of more than £2000, it may recover the input tax on them. If the goods are subsequently sold, VAT must be accounted for at the full rate not the reduced rate.

Once the scheme has been joined a business may stay on this scheme providing its turnover does not exceed £225000 in any 12 month period. If a business expects to exceed £225000 turnover in any 3 month period it must leave the scheme immediately.

Who cannot Join the scheme?

You cannot join the scheme if any of the following apply:

• The business is not registered for VAT
• The business is using the second-hand margin scheme
• The business is required to operate the tour operators margin scheme
• The business is required to operate the Capital Goods Scheme for certain capital items
• The flat rate scheme has stopped being used in the 12 months prior to the date of a new application
• In the last 12 months before an application the business has either accepted a compound penalty or been convicted of an offence in connection with VAT or been assessed with a penalty for any conduct involving dishonesty
• The business is or has been, within the last 24 months, registered for VAT in the name of either
• a VAT group
• a division

The business is associated with another in any of the following ways

• A business is under the dominant influence of another
• Two businesses have close financial, economic and organisational links or
• Another company has the right to direct the business applying
• In practice the business complies with the directions given by another. The test involved here is one of commercial reality rather than legal.

Advantages

• There is no need to separate out gross, VAT and net in the business accounts
• No problems in deciding what input tax can and cannot be reclaimed
• Less chance of making mistakes in calculating VAT liability
• Less work doing the books
• Can be used in conjunction with the annual accounting scheme

Disadvantages

• The business cannot claim input tax so it loses some cash flow in VAT on stock waiting to be sold
• The lesser requirements to keep VAT records make it more difficult to continue to monitor whether the scheme is still advantageous

There are 16 groups of zero rated items, the main ones are

• Food, except when supplied in the course of catering or a non essential item such as chocolate, ice cream, alcoholic and fruit drinks and crisps.
• Water and sewerage services except where supplied for industrial purposes.
• Books (but not stationery)
• Construction of buildings for residential or charitable use.
• Children's clothing and footwear.
• Transport (but not taxis or hire cars)
• Drugs and medicines on prescriptions
• Exports

Businesses with an annual tax exclusive turnover of up to £1350000 that have been registered for at least one year may apply to join the annual accounting scheme. The business agrees a provisional VAT liability with Customs and Excise based on the previous year.

Businesses with a taxable turnover of £150,000 or less can join the scheme as soon as they are registered with their provisional figure being estimated.

For businesses with a turnover above £150,000, the agreed provisional liability is divided by ten. Nine equal monthly payments are made by direct debit starting four months after the beginning of the year.

Businesses with a turnover below £150,000 can make quarterly payments that are 25% of the provisional VAT liability.

The annual return and the balancing payment has to be made within two months of the year end. Once a company joins the scheme it can remain in it unless its annual turnover reaches £1600000.

Advantages

• An eligible business can choose an annual accounting year which best suits its business needs
• The annual VAT return and balancing payment will be due two months after the end of the annual accounting period instead of one with the standard scheme.
• A business will only have one vat return to complete rather than four on the standard scheme.
• The business can measure its cash flow with more certainty by paying a known set amount each month rather than having the potential surprise of a large bill at any time.

Disadvantages

• Traders who are due a repayment will not need to make monthly repayments but will not receive a repayment until their return is made
• The business still has to maintain its VAT records (compare with flat rate scheme)

Items currently charged at the reduced rate of 5% are

• Fuel and power for domestic and charitable use
• Installation of energy saving materials eg. Loft insulation in residential or charitable buildings
• Grant funded installation of central heating systems, water heating systems and home security goods
• Children's car seats
• Women's sanitary products
• Certain residential conversions, renovations and alterations.

Providing a business is up to date with its tax returns, has paid over all of their VAT or have made arrangements to pay the outstanding VAT by installments and has a turnover which is not more than £660,000, it can improve its cash flow by not having to account for its output tax until the cash is received. On the other hand input tax is not recoverable until suppliers are paid.

Businesses cannot use the scheme for hire purchase, goods and services invoiced in advance of the supply or where payment is not due for more than six months after the invoice date.

Broadly speaking supplies categorised as exempt are

• Betting, lotteries and Gaming (Except takings amusement machines).
• Burial and Cremation
• Charity fund raising events
• Education
• Financial services
• Health and welfare services
• Insurance
• Investment gold
• Land
• Postal services
• Supplies of goods on which no input tax was recoverable
• Supplies to members by trade unions and professional bodies

If a business makes only exempt supplies it does not charge vat but cannot recover input tax charged to it therefore its prices need to be set to recover the vat suffered.

Some businesses may make both taxable and exempt supplies and are therefore partially exempt. A business that is partially exempt can still recover all of the input tax despite the exempt supplies IF the input on exempt supplies does not exceed 50% of the total input tax and does not exceed "625 per month on average.

If these limits are exceeded there are rules to determine how much of your input tax can be recovered:-

All of the input tax directly attributable to taxable supplies can be recovered but none of the input tax attributable to exempt supplies.

As to the remainder of the input tax that relates to overheads, under the standard method input tax is deductible in the proportion that taxable supplies bear to total supplies.

If a taxpayer fails to make a return or Customs and Excise considers that the return is incomplete or incorrect, they may issue assessments of the amount of VAT due. These assessments must normally be issued before the expiry of two years from the end of the return period or within twelve months after the facts become known, whichever is the later.

Where a taxpayer has died, no assessment can be made later than three years after death nor relate to a period more than three years before death.

Where an assessment has been made the taxpayer must still provide a return and should notify Customs and Excise within 30 days where the correct amount payable exceeds the assessment.

Businesses are liable to register for VAT if the taxable turnover of the business in the last 12 months exceeds £70,000 unless they can satisfy Customs and Excise that their taxable turnover in the next 12 months will not exceed £70,000.

The business must notify Customs and Excise within 30 days of the end of the month in which the yearly limit was exceeded and will be registered and required to charge VAT on all your invoices from the beginning of the next month.

There is a penalty of 15% of the net tax due for failure to register, with a minimum penalty of £50. Registration is done on form VAT1 which can be ordered from Customs and Excise or downloaded from their website

www.hmce.gov.uk

In addition to their right to commence criminal proceedings (for other than regulatory offences), Customs and Excise can charge interest on overdue tax and can impose penalties for

• Late, incorrect or incomplete returns
• For failure to notify liability to be registered for VAT
• Issuing unauthorised VAT invoices
• Failure to keep proper records (which have to be retained for six years

A business can voluntarily register if it makes taxable supplies even though it may be below the statutory limits.

Once it is registered it will charge VAT on its supplies (Invoices) and reclaim input tax that it is charged on purchases. This would be beneficial if all or the majority of its customers are VAT registered but not if it deals mainly with the general public. By registering it will have the administrative burden of complying with the VAT scheme and therefore this may not be worthwhile even if there is a cost advantage.

Supplies of goods between EU countries are not regarded as imports and exports but as acquisitions and supplies. If a supplier in another EU country supplies goods totaling more than £70,000 in a calendar year to non-registered persons in the UK (known as distance selling), the supplier is liable to register in the UK within 30 days of exceeding the limit.

If a UK non-registered business makes acquisitions from other EU countries in excess of the stipulated threshold, the registration and de-registration provisions stated above apply.

When a VAT registered person acquires goods in the UK from an EU supplier, output tax must be accounted for on the next VAT return, but wit an equivalent amount being deducted as input tax on the same return.

Supplies by a UK supplier to VAT registered EU customers are zero rated. A UK seller must state both his own and his customers VAT number on VAT invoices. In addition to his normal VAT return the supplier has to submit a return of all supplies to VAT registered customers in the EU for each calendar quarter (known as an EC Sales list)

If you have started in business but are not currently making taxable supplies but intend to do so in the future, you may apply for registration and Customs and Excise are required to register. This enables you to recover any input tax even though no supplies are being made.

There are a number of situations where a business can apply to cancel its VAT registration

• The business stops making taxable supplies
• The legal status of the business changes e.g. a sole trader becomes a limited company. The old registration will be cancelled and a new one applied for. The new legal entity can retain the previous registration number by completing form VAT68. (If the new legal entity is a partnerships it will also need to complete form VAT2)
• The business can satisfy Customs and Excise that its taxable turnover in the next twelve months will be below the current VAT de-registration threshold of £68,000.
• The tax-exclusive turnover of the business in the past 12 months has been below the current registration threshold of £70,000.
• The business turnover exceeds the registration threshold but its taxable supplies are wholly or mainly zero-rated
• If the business is sold and the new owner does not wish to retain the registration number