VAT for small business: when to register, how to reclaim

Published • 01/07/2024 | Updated • 01/07/2024

Taxes

VAT for small business: when to register, how to reclaim

Published • 01/07/2024 | Updated • 01/07/2024

Taxes

As a small business owner, you’ll run into several types of taxes. For example, if you rent commercial property, you’ll probably pay Business Rates, and if you’re setting up a limited company, then your profits will be subject to Corporation Tax. Add Income Tax and National Insurance into the mix, and there’s a lot to consider.

Then there’s VAT, or value added tax, which takes the form of a fee added at each stage of producing and distributing goods and services.

VAT impacts all kinds of enterprises, from home-based side hustle ideas to high street retail businesses. Whether or not you’re registered for VAT, you’ll likely deal with suppliers who are. This means you’ll pay VAT on their products and services and need to account for this in your pricing strategies, even if you’re not the one collecting VAT yourself.

So just what is VAT, and how does VAT work for small businesses? Everything’s covered in this guide, where we’ll explain the ins and outs of this tax, including the VAT threshold for small business registration, and what records you need to keep.

We’ll also cover different VAT schemes, tips to help you manage VAT more effectively, and provide guidance on working out what you owe and filing your returns.

Understanding VAT is essential for everything from day-to-day operations management to creating an accurate small business budget. Knowing how VAT works and what you need to pay helps you plan your small business finances better, ensuring you set aside enough funds to cover these costs.

What is VAT for small business?

VAT is a tax on the value added to a product or service at each stage of its lifecycle. While consumers ultimately bear the cost, businesses charge, pay, and collect VAT for HMRC.

The UK has three main VAT rates:

  • Standard (20%) – Applies to most goods and services.

  • Reduced (5%) – Applies to specific items like children’s car seats and home energy.

  • Zero-rated (0%) – Applies to specific items like books, children’s clothes, and most foods.

Some goods and services, such as those related to finance, education and insurance, are exempt from VAT and aren’t taxable. Exemption differs from zero-rating. If your business deals only with exempt items, you can’t register for VAT. Also, certain things like voluntary charitable donations are outside the scope of VAT.

VAT explained for small businesses

To see how this works in practice, let’s imagine you’re running a business selling outdoor furniture and equipment to the food and drink industry. You buy an outdoor heater from a supplier for £200. The supplier, who is also VAT-registered, adds 20% VAT (£40), making your total cost £240.

You sell the heater to a pub for £300. Since you’re also a VAT-registered business, you must add £60 VAT (20% of £300). Your pub landlord customer therefore pays you £360.

Here’s how it works with HMRC:

  • You paid £40 VAT when you bought the heater.

  • You collected £60 VAT when you sold it.

  • You report both amounts to HMRC.

  • The difference, £20 (£60 collected - £40 paid), is owed to HMRC.

What is the current VAT threshold for small businesses?

Your business’s taxable turnover, which is your total income from selling VAT-rated goods and services, will determine whether you need to register for VAT. Registration becomes mandatory in either of these scenarios:

  • Your VAT taxable turnover in a 12-month period exceeds £90,000.

  • You expect your turnover to exceed the threshold in the next 30 days.

If turnover exceeds £90,000 in the past 12 months

If your VAT taxable turnover surpasses £90,000 in any rolling 12-month period, you need to register for VAT within 30 days after the month in which you reach this threshold. Your business’s VAT registration starts on the first day of the second month after its sales exceed the limit.

For instance, if your retail store’s VAT taxable turnover hits £92,000 between 10 October 2024 and 9 October 2025, you’ll need to register by 30 November 2025, and your VAT registration will take effect on 1 December 2025.

If turnover will exceed £90,000 in the next 30 days

If you anticipate that your business’s VAT taxable turnover will exceed the VAT registration threshold in the next 30 days, the registration timeline is shorter. You need to sign up by the end of that 30-day period.

So, let’s say your consulting firm secures an unexpected £10,000 contract on 1 June. If full payment is expected by the end of the month and this will push your taxable turnover over £90,000, you must register by 30 June.

Here, your effective date for VAT registration would be 1 June – the date you realised your small business would become liable for VAT.

Voluntary VAT registration for small businesses

VAT registration isn’t mandatory unless your taxable turnover hits the threshold. However, you can still choose to register voluntarily, even if you haven’t reached the £90,000 mark yet.

Why would you do this? Well, if you’re planning how to start a business and your cash flow forecast shows that you’ll soon exceed the VAT threshold, it might be smart to register right away. This way, handling VAT becomes routine from the off.

We’ll take a closer look at the perks of VAT for small business owners in the next section. As with any business decision, it’s important to weigh the pros and cons to make sure it’s the smart choice for your enterprise.

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Pros and cons of VAT registration for small businesses

There are benefits to becoming VAT registered, along with potentially significant drawbacks to consider.

Advantages

Disadvantages

Enables VAT reclaims

As a VAT-registered business, you can recover the VAT paid on your small business expenses, reducing your overall costs.

Increased admin and costs

Registering for VAT entails more record-keeping and may result in higher expenses for VAT software or accounting services.

Improves credibility

Being VAT registered can make your business seem more credible and established, which can help with how to get clients.

Cash flow challenges

Managing VAT can complicate your cash flow, as you need to handle the VAT you collect and may face delays in reclaiming the VAT you pay out.

Encourages good business practice

Properly handling VAT encourages you to stay diligent about your overall finances and tax affairs, which can aid in small business risk management and reduce the risk of falling foul of penalties.

Impact on pricing

Adding VAT will make your products and services more expensive, potentially putting you at a disadvantage compared to non-VAT-registered competitors, and perhaps affecting sales to customers who can’t reclaim VAT.

Prepares for growth

VAT registration can place you in a better position, with regards to finances and reputation, when you’re planning how to scale a business effectively.

Unlocks new opportunities

Some companies prefer, or are required, to work with VAT-registered businesses, so registering will open doors to new business opportunities.

Understanding the potential for higher pricing due to VAT highlights how important it is to learn how to do a competitor analysis. By studying your rivals’ pricing strategies and how they handle VAT, you can adjust your own pricing to stay competitive.

How to register for VAT

Registering for VAT is usually done online. You’ll need a Government Gateway ID and password, which you can set up during your first sign-in if you don’t already have them.

Before you begin, gather some information based on your business type. For a limited company, this includes your company registration number, and for a sole trader, your National Insurance number. You must also provide your annual turnover and business current account details. HMRC provides a full list of what you’ll need.

After registering

Once you’ve successfully registered your small business for VAT, you’ll get several key items by post:

  • A VAT registration certificate with your 9-digit VAT number.

  • Instructions on setting up your business tax account if you don’t have one.

  • Guidelines on when to submit your first VAT return and make your payment.

  • Confirmation of your VAT registration date.

A current account for every business

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Responsibilities of VAT-registered businesses

Once you’ve signed your small business up for VAT, there are a few rules you need to follow. You must:

  • Charge the correct VAT rate on all goods and services

  • Keep records of the VAT you charge and pay

  • Submit VAT returns to HMRC

  • Pay any VAT owed to HMRC

Charging VAT

As a VAT-registered business, you must add VAT at the correct rate to the price of the goods and services you sell. Additionally, your invoices must clearly display your VAT number and the amount of VAT charged.

Most businesses use software to calculate VAT, but it’s useful to understand how it works. Here’s how to add VAT to a price:

  • To add 20% VAT, multiply your selling price by 1.20.

  • To add 5% VAT, multiply your selling price by 1.05.

Easy VAT invoicing

SumUp’s smart invoicing software simplifies charging VAT. Enter your customer and item details, and the software automatically generates the invoice number, total price, and VAT, making the invoicing process smooth and seamless.

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VAT records

The introduction of the Making Tax Digital scheme means you must use HMRC-approved software to keep digital VAT records. Here’s what you need to track:

  • VAT you’ve charged – Known as output VAT, this includes VAT on all the VAT-rated goods and services you’ve sold.

  • VAT you’ve paid – Known as input VAT, this includes VAT on all the VAT-rated goods and services you’ve bought.

VAT software works out the difference between your output and input VAT to determine if you owe a payment to HMRC or if you’re due a refund. As such, tracking VAT payments will be part of your regular bookkeeping for small business routine.

VAT returns

VAT returns are the forms you submit to HMRC to report the amount of VAT you’ve collected and paid. The default is for you to file a VAT return quarterly – a three-month period known as your accounting period.

You must submit VAT returns for your small business when they are due, even if there is no VAT to pay or reclaim. Here’s a quick guide to how to do it:

  • Log into your Government Gateway account.

  • Authorise your VAT accounting software to communicate with HMRC.

  • Follow your software’s instructions on how to submit a return.

  • Remember to stick to any deadlines.

The deadline to file your VAT return online and pay any VAT owed to HMRC is typically one month and seven days after the end of your accounting period.

Paying and reclaiming VAT

VAT bills are typically paid online. There are various payment methods available, such as bank transfers, corporate credit card, and direct debit. You can also pay in person at your bank or building society, and in some circumstances, by standing order.

No matter which option you choose, be sure to have your VAT number to hand, and remember to leave enough time for your payment to reach HMRC.

VAT refunds are typically issued automatically, either direct to your business account or by cheque, usually within 30 days of you filing your return.

VAT schemes for small businesses

HMRC offers several voluntary VAT schemes you should be aware of. They won’t change the amount you add to your products and services, but can make handling VAT simpler.

What is the VAT flat rate scheme for small businesses?

The VAT flat rate scheme is tailor-made for businesses with a taxable turnover of £150,000 (ex. VAT) or less. It allows you to pay VAT as a fixed percentage of your total sales (inc. VAT). The percentage you pay depends on either your business type or how much you spend on goods.

  • Limited cost businesses – You’re considered a limited cost business if the cost of your goods is less than 2% of your turnover or £1,000 per year (whichever is higher). Limited cost businesses pay a flat rate of 16.5%.

  • Business type – If you don’t have a limited cost business, the percentage of VAT you pay depends on your business type. For example, travel agencies pay 10.5%, while management consultancies pay 14.5%.

Usually, you can’t reclaim VAT when you’re on the flat rate scheme (except on certain purchases), but you get to keep the difference between what you charge customers and what you pay to HMRC.

This can be a win if your business pays a lower VAT rate than it charges. For example, if you’re charging 20% but only paying 10.5%, you could come out ahead.

If you’re thinking about how to improve cash flow, the flat rate scheme is definitely something to consider if your business qualifies. You’ll even get a 1% discount in your first year as a VAT-registered business.

However, it’s not for everyone. Say you run a bakery and mostly sell zero-rated items like bread. You won’t be collecting much VAT, but despite this, you still can’t reclaim VAT on things like new ovens or new card readers for your shop.

In short, the flat rate scheme can be worthwhile, but make sure it fits your business needs before diving in.

Alternative VAT schemes

In addition to the flat rate scheme, you might consider these other options. Some can be combined with the flat rate scheme to make things even easier.

  • Annual accounting scheme – Lets you file just one VAT return a year instead of four. This is available if your VAT taxable turnover is £1.35 million or less.

  • Cash accounting scheme – Lets you pay VAT to HMRC when your customer pays you, not when you send out the invoice. This also open to businesses with a VAT taxable turnover of £1.35 million or less.

  • Retail scheme – Great for retail businesses, with three options available to you: point of sale, apportionment, and direct calculation. These let you figure out VAT for each return as a whole rather than per sale. You can use them with the annual and cash accounting scheme, but not with the flat rate scheme.

  • Margin scheme – Perfect for businesses dealing in second-hand goods like art and collectibles. You only pay VAT on the profit margin (the difference between what you paid and what you sold it for) instead of the full sale price.

How to manage VAT effectively

Even if you’re using one of the VAT schemes, managing VAT can seem daunting. But with the right approach and tools, it can be made far more manageable. Here are some small business tax tips to help you stay in control.

1. Be clear on the rules

Make sure you fully understand the rules around VAT for small business. This includes knowing when and how to register for VAT, which products and services are taxable, and at what rates.

Deadlines are really important too. Whether you’re signing up for VAT for the first time or filing a VAT return, keep an eye on the relevant time limits.

2. Tap into the right software

There are many software options to help you record and report VAT for your small business. It’s worth taking the time to find the tech tool that fits your business best.

You can go for dedicated VAT software for small business owners, or choose a broader solution that also offers additional accounting tools for small businesses, optimising how you create cash flow statements and balance sheets. If you have staff, some programs can also help with how to do a payroll.

3. Plan ahead to stay ahead  

Planning for VAT is really important. If managed well, VAT funds can give your working capital a boost, as long as your cash flow forecast shows you can replace the money when payment is due.

However, if cash flow is tight, it’s probably better to set the VAT aside in a savings account to avoid any last-minute headaches when it’s time to pay up. This way, you can keep your business running smoothly and avoid any financial upsets.

4. Get expert help

As a small business owner, you’ll likely have your hands full with all kinds of tasks, from deciding how to advertise your business to exploring how to provide customers with new payment options like gift cards and QR codes

With free time at a premium, you may want to look into how to hire employees with the specialist skills for managing VAT and other financial matters. Alternatively, it may be worth hiring accountancy or professional tax services professionals who can shoulder the burden and let you focus on your core operations.

5. Turn to technology

Beyond choosing the right VAT software for your small business, other forms of tech can make it much easier to keep on top of your financials. For example, SumUp’s point-of-sale systems and self-service kiosks will automatically apply the right VAT rate when you ring up a sale in your hospitality business, making managing VAT easier and more accurate.

Discover the SumUp Kiosk

Whether you’re running a café, a bar, a quick-service restaurant, or a live entertainment venue, SumUp’s self-service kiosks not only simplify adding VAT; they bring increased sales and reduced queues while freeing staff up to get on with other things.

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Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.

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