Value Added Tax is a tax on levied almost all goods and services in the UK. If you’re setting up a limited company, chances are you will also register for VAT, so here is our overview of VAT – what it is, how to register, and how to avoid potential problems.
Registering for VAT
Your company must register for Value Added Tax if your 12-month turnover is, or is expected to breach the prevailing VAT registration threshold (this is £85,000 for the tax year beginning 1st April 2021 – same as the previous tax year).
In the unlikely event that you think your company will breach this threshold in the next 30 days alone (due to a very large incoming payment, for example), then you must also register right away.
In practice, accountants will advise their contractor clients to become VAT registered regardless of their projected, or current turnover, as there are many benefits to doing so.
For example, you will be able to reclaim the VAT on any business expenses you incur (e.g. buying a new PC), being VAT registered will make your company appear more professional, and if you join the Flat Rate VAT scheme (more on this later), you could actually pay less tax overall as a result.
Your accountant should take care of your VAT registration for you – this is one of the first tasks they will carry out when you set up a new company. This can be done online on your behalf (as you will appoint your accountant to act on your company’s behalf) or via the paper form VAT1.
Visit GOV.UK for more in-depth information on the setup process.
(If you’re an umbrella company contractor, you need not concern yourself with VAT, as your umbrella company will take care of all tax-related administration, so the information in this guide is aimed at limited company contractors).
How long will it take before I receive my company VAT number?
This is a very frequently asked question by new contractors. There is no guarantee of when you will receive your registration number. At times in the past, new companies have had to wait over a month, even though HMRC currently advises that “you should get a VAT registration certificate within 14 working days, though it can take longer.”
Importantly, you must not charge VAT on your invoices to your agency/client until you have your VAT number but should increase your prices by 20% (the standard VAT rate) in the short-term, and then reissue the invoices with the correct breakdown between net service costs, and the VAT element. Your agency/client will have encountered this on many occasions, so let them know if you need to invoice before you are VAT registered.
Different types of VAT scheme
HMRC operates several different VAT schemes to suit a multitude of businesses;
1. Standard VAT scheme – you invoice customers at the standard rate and repay VAT to HMRC based on the total amount of VAT you have charged on outstanding invoices, minus any VAT you have paid out via your business.
2. Cash Accounting scheme – the same as the above, except you only repay VAT to HMRC once you have actually received the funds from your customers and clients. You can only reclaim VAT on purchases when you have actually paid the supplier for them. This can be useful for cashflow purposes.
3. Flat Rate VAT scheme – a scheme which is often used by limited company contractors, it was designed to make accounting easier. You still invoice clients at the standard rate, but you pay HMRC a fixed percentage rate of your quarterly turnover, according to the industry you operate in. For IT contractors, the rate is 14.5%, and in the first year of operation, you can benefit from a 1% reduction to his fixed rate. Please note that, from April 2017, new ‘limited cost trader’ rules have removed the benefits of using the Flat Rate VAT scheme for many small companies, particularly those with low quarterly costs.
Your accountant will be able to advise you which scheme is most suitable for you. You can find out more about the various schemes on the HMRC site here.
Accounting for VAT
Once you are registered for VAT, you must include certain information on all your invoices to your agency or client. We have a dedicated article explaining which fields you must include, together with Word and Google Docs templates here.
These days, all ongoing VAT communication with HMRC is carried out online. You (or more likely, your accountant) must submit your quarterly return within one month of your company’s quarterly end-date, and pay any VAT you owe by the same deadline. If you set up a direct debit with HMRC, you will be allowed an extra week beyond the deadline before funds are automatically deducted from your business account.
The penalties for non-registration and late payment of VAT liabilities are fairly hefty, so you must make sure you (and your accountant) keep on top of your company’s tax accounting.
In our experience, missing the occasional quarterly VAT deadline is something a fair few contractors have done (ourselves included). On the first occasion, you will typically receive a ‘help’ letter, but no action is taken as long as you don’t ‘re-offend’ over the coming 12 months. A stiffer letter is usually dispatched if you offend a second time, and beyond that, your company will then be liable for a ‘surcharge’ of between 2% and 15% depending on the number of offences.
Clearly, it is in your best interests to avoid these penalties, and the increased scrutiny HMRC may take into your accounts, so make sure you double-check that your accountant is processing your VAT returns on time, and consider setting up a direct debit so that you won’t ever miss a payment.