How to Register for VAT, Should You Avoid VAT, and Why? The Pitfalls.

Should you register for VAT?, I get a lot of different questions about a lot of different topics. Most of the time, I have an answer but every now and then, I have to go out into the world and carry out some research because I just don’t know something that well.

I was recently asked by an acquaintance about VAT registration for a side venture that had been set up.

I always knew the basics of VAT. Being me however, I felt that I had to find out more about VAT registration, what the pros and cons are etc. To me, it always seemed like a no brainer. I know people who claim their VAT back on purchases and whatnot and they’re forever twisting things into business purchases and bragging about how easy it is.

I had always taken this for granted, simply because it wasn’t something that ever really affected me. Once I realised how little I knew it became like a loose thread for me, and well, here I am.

Over the course of this article I want to explore the pros and cons of being VAT registered. More importantly, I want to look at it in as much detail as possible. I have read a few articles whilst carrying out my research, but truthfully, most of them simply skim over things.

They also have a strong bias on account of them being written by different accountants and financial software companies. With this in mind, here are my findings.

Just on the basis of gathering real life information, I have gone to the lengths of actively speaking to a fair amount of business owners who are VAT registered, and those who are not, to gain some ‘real’ feeling on the subject, as I think you will see on the content below.

What is VAT?

In my personal opinion, and that of some business people I have spoken to, VAT is simply another taxation. Made up taxation where justification for such was simply built around it after the event.

Nobody likes taxes, especially business taxes where there is far more value being offered to society (in the main) than is given credit for.

Therefore, it has been said by quite of few of those I spoke to, that is is just another form of taxation, and that starting and running a business these days means that you are effectively taking 50% out of your coffers before costs and personal income.

It was broken down like this:

Let’s say your business turns over £100,000 a year, then you are immediately losing 20% of that in VAT (tax), and then another 20% of that taken in corporation tax (depending on which side of the bed the Chancellor gets out of on budget day, give or take a few %’s).

Then you are paying employee’s National Insurance contributions, and now their pension contributions, etc.  – give or take what you can claim back and it is said that approximately 50% of your profits are wiped out before you even begin to look at product costs, etc.

Then after all this taxation, when you look to pay yourself some dividends out of what is left, now you are met with at least another 7.5% dividend tax which is placed on top of the rather large heap of other taxes you have have paid to the treasury.

Is it little wonder that businesses really don’t like such taxes, after all the hard work they put into building their businesses? and then having to hand over 50% of their profits to pure taxation, and government interference which then go to fund spurious mandates that hold endless wastage.

Anyway, back to the facts and my VAT findings:

VAT

The first place that my search led me to is what VAT actually is. Sure, we all know that VAT is charged at 20% (at the time of writing) on top of purchase prices.

Here in the UK, VAT is also typically factored into purchases meaning that £2 in £10 that you spend on VAT applicable items  ultimately goes back to the Government of the day.

All of the above is pretty straight forward, but I hadn’t considered VAT outside of this context. For example, a company, in charging VAT essentially acts as a tax collection agency on behalf of HM Revenue and Customs.

This almost sounds ludicrous but because of how VAT is handled by companies, this is what they do (I will go into this in much greater detail below so don’t worry if you’re a bit lost. This is a surprisingly deep subject).

So deep in fact, that the varying opinions from businessman that are VAT registered may surprise you. In my research I have found that many business people have a lot to say about the subject, and most of it is from the stance of VAT being a punitive, enforced tax on businesses – especially when the customer is non-commercial, but a retail buyer.

Investopedia wisely summarises VAT as a type of consumption tax which is “placed on a product whenever value is added at a stage of production and at final sale”. This means that as a consumer, you don’t just pay VAT when you buy a completed product.

Each component purchased by a company may have had VAT applied, and the producer of the component may have payed VAT on raw materials and so on and so forth. This isn’t necessarily the most pertinent information, but I found it to be interesting and it does help to create some context later on.

The following link explains how to actually register for VAT (read this review first though!):

https://www.gov.uk/vat-registration/how-to-register

As a company, you naturally have to pay any VAT that you have collected as well as reclaim any VAT that you have paid on business expenses. This typically happens on a quarterly basis.

Whilst there are some exceptions, these are more unusual examples and apply to companies with a turnover of £1.35 million plus. They also seem to be better equipped for big businesses rather than smaller ones.

Does My Business Have To Be VAT Registered?

The short answer to this is that it depends on how much money your company makes. The criteria set by the Government in the UK is as follows:

You must register for VAT if:

  • Your VAT taxable turnover is more than £85,000 (the ‘threshold’) in a 12 month period.
  • You expect to go over the threshold in a single 30 day period.]

There are also some addendums to this as well.

  • You’ll also need to register if you only sell goods or services that are exempt from VAT or ‘out of scope’ but you buy goods for more than £85,000 from EU VAT-registered suppliers to use in your business.
  • You may have to register for VAT if you take over a business that’s already registered.

I would like to make a point of clarification at this point. The £85,000 that is referred to is your turnover. This means that even if your business is only making £1 profit per annum, if your takings are £85,000 or above then you must be VAT registered.

Furthermore, this number applies only at the time of writing and is subject to change in the future.

Outside of this, being VAT registered is an entirely optional thing. This is where it makes sense to introduce the pros and cons of being VAT registered. There are certainly some strong arguments to be had both for and against voluntary VAT registration.

What Are the Pros of Being VAT Registered

Most of the sources that I have looked at have do nothing but sing the praises of being VAT registered. Honestly, I can see why this would be the default view. If you are a large company, there only appears to be benefits to being VAT registered.

Given that this article is generally geared towards those who have a choice (and as such, are likely to have smaller companies), this will be my focus.

One of the first things that stands out as a benefit for smaller companies considering voluntary VAT registration is that it can boost the profile of your business. When engaging in business, anybody worth their salt will know what the VAT threshold is.

Where this can be used for your benefit is that if you have a VAT number, it creates the appearance that your company has a minimal turnover of £85,000 per year. Given that some businesses may be wary of dealing with significantly smaller companies, seeming bigger than you are can be a huge boon.

pros and cons of VAT

This also brings me onto my second point which is ease of business. Based off my research I have seen anecdotal evidence of companies being much less receptive to none VAT registered companies.

Truthfully, this doesn’t seem to be too big an issue in this day and age, however it is something to keep in mind. Irrespective of whether companies will or won’t deal with you, having a VAT number does make the whole transaction process easier for everybody involved.

Having mentioned the VAT number, it is probably worth taking a little bit of time to talk about this. A VAT registration number allows you to be identifiable as a VAT registered business. By having this displayed on your website, stationary and correspondence, it all adds to sense of a big business.

It is also something of a professional courtesy that allows anybody doing business with you to understand that they’re not dealing with “cowboys”.

These are ‘some’ positives however I doubt that they are why you are reading this article. The main reasons for voluntary VAT registration are of course financial. This mostly comes in the form of reclaiming VAT on applicable business purchases.

How To Reclaim VAT

Gov.uk says that you can usually reclaim the VAT paid on goods and services purchased for use in your business. You can also partially reclaim VAT on any purchases that are for personal and private use. This split is typically based around how much you will use a purchase for personal, and how much you will use a purchase for business use.

As an example, I will imagine that I am a VAT registered company owner and I have just purchased a new laptop for myself. 75% of the time, I know that I will be using my laptop for business related services.

This means writing reports, composing business related emails etc. The other 25% of the time, I will be using it at home to browse Facebook, play a bit of online poker and watch Netflix. I can reclaim 75% of the VAT that I paid on the laptop.

reclaim VAT

What this means in pounds and pence terms can be very attractive. If I had spent £1,000 on my new laptop, then £200 of that would be VAT. Of that £200, I could claim back 75% (the business usage) which means that I could reclaim £150 (staggered over a period of time…!).

This means that my £1,000 laptop has effectively cost me £850 because I will use it for business purposes.

The following link will advise on what can be reclaimed on the VAT, and what cannot:

https://www.gov.uk/reclaim-vat/what-you-can-and-cant-reclaim

This is only one aspect of what you can reclaim however. If you have a mobile phone on contract that is purely for business use, you can reclaim 20% of the purchase cost as well as the cost of the plan.

On a £50 per month contract, this means reclaiming £120 over the course of a year. If you work from home and your home office takes up 10% of the floor space of your house, you can reclaim 10% of the VAT back on your utilities.

Unfortunately, there are some exceptions to this and I would strongly advise that you research what you can and can’t reclaim before rushing into a purchase. Especially if it is on the grounds that you will get some money back on it.

A prime example of this is the fact that you cannot recover VAT on a car for partial business use. If you can prove that a car will be used solely for business use, then you can attempt to reclaim the VAT.

Reclaiming VAT Expenses

The savings that you can make through reclaiming VAT are not necessarily massive amounts on their own. 10% of the VAT on your utility bills might only work out at 2% overall, but this is money that you can essentially claim back “for nothing”.

Really, the numbers only start to come together when you start to factor in all of the day to day costs of running a business.

It is also worth noting that you can reclaim costs staff travel for business trips. This means that if any of the following travel, you can reclaim VAT on travel expenses including meals and accommodation:

  • Someone directly employed by you, i.e. not through an agency.
  • Directors, partners, any other managers.
  • Helpers or stewards who help run events.

There are however different rules when it comes to reclaiming VAT on fuel. Presuming you don’t pay a fixed rate of VAT under the Flat Rate Scheme (something that I will get to soon), then there are 2 main ways of reclaiming (or not reclaiming, as the case may be) VAT on fuel. These are as follows:

  • You can reclaim all the VAT that you pay on fuel and pay a fuel scale charge for your vehicle.
  • You may choose not to reclaim any VAT if your mileage is so low that the fuel scale charge would be higher than the VAT you can reclaim.vat expenses claim

Having mentioned the fuel scale charge, I should now take a look at what this entails. If you drive a car and choose to claim back all VAT on fuel, then you have to pay a fixed fee which depends on the type of vehicle you drive and how you choose to pay.

For example, a BMW 320d would mean paying £65 per month, £197 per quarter or £792 for the year between May 2016 and April 2017 (the last financial year).

Essentially, the fuel scale charge is a “fair” charge that the Government levy to cover any VAT that you recover on your fuel costs that may have been used for personal use. I promise, it is simpler than it sounds.

Basically, if you owned a BMW 320d (as used in the example), you would pay £792 per year on top of your VAT. In return, you can claim VAT on all of your fuel purchases.

Using the above example and diesel prices of £1.20 per litre, we can see that you would be reclaiming 24p on each litre of fuel. Over the course of a year, this would mean that you would have to purchase 3,300 litres of fuel in order to benefit from paying the Fuel Scale Charge.

This is a big part of the reason that some smaller businesses find it easier to simply pay VAT on fuel.

Reclaiming Historic VAT

When you become VAT registered you are also able to claim back some of your historic VAT payments. Whilst there is a time limit in place, you can claim for goods up to 4 years old that you either still have, or that were used to make goods that you still have.

There is also a 6 month limit on services provided.

It is worth keeping in mind that when it comes to reclaiming historic VAT, it must be related to your “business purpose”. What this means is that any historic VAT that you try to claim must relate to VAT taxable goods or services that you currently supply.

It should go without saying that you will have to provide invoices, receipts and other evidence to back all of this up.

What Are the Cons of Being VAT Registered?

I think that one of the most obvious cons that I have found when researching this topic is that VAT can become a complicated beast. For some people, the amount that they will ultimately be able to reclaim simply isn’t worth the paperwork involved. Especially if you are a one man operation and don’t have an accountant in place.

Ultimately, I think that this comes down to how much you value your time. If 8 hours of paperwork is going to allow you to reclaim £500, then it is a bit of a no brainer. If however you can only reclaim £80, you may find something better to do with your time. Like I have said, this is really a bit of a personal preference situation.

The laws and rules regarding bookkeeping and administration when you are VAT registered are also somewhat more specialised. Because you are essentially collecting money on behalf of HMRC, everything has to be done in a very specific way.

With a decent accountant and you keeping detailed and correct records, this doesn’t have to be a big deal. It does however come once more back to the time you have to invest and whether or not this balance works out right for you.

One of the bigger problems associated with being VAT registered is that with small companies/businesses, it can cause cashflow problems. You have to pay any VAT that you have collected on a quarterly basis. If you are unprepared, this can catch you short, especially if you have generated more VAT from goods and services than you have paid to other businesses.

On top of this, there can be fines and penalties if your submissions are late and incorrect. Naturally, these aren’t cheap and  furthermore, they can quickly build up if you are late with payments etc.

Like a lot of the downsides of being VAT registered, this is something that can be easily eradicated with a decent accountant but if your business is new, this will prove a costly option.

All of this can be done manually, but we are back at square one with the volume of paperwork and how much you value your time.

VAT Flat Rate Scheme – Now Rendered Useless

Generally speaking, the amount of VAT that your business will pay (or claim back) is the difference between the VAT that you have charged customers and the VAT that you have paid on your own business purchases. There is however a scheme that some small businesses can take advantage of that can simplify the process.

The following is the eligibility for joining the flat rate scheme:

https://www.gov.uk/vat-flat-rate-scheme/eligibility

With the VAT Flat Rate Scheme, as the name well suggests, you simply pay a flat rate to HMRC and in return, you keep the difference between what you charge your customers and what you pay to HMRC. This sounds rather complicated but actually, it is rather straight forward.

vat flat rate scheme

Depending on what industry your business is in, you pay an agreed rate of VAT and get to keep the difference between that and the 20% that your customers should be charged. For example, if your business involves retailing vehicles or fuel, you will pay 6.5% VAT and get to keep the other 13.5% that you charge your customers.

This is however only eligible for businesses to join who have an expected taxable turnover of less than £150,000 in the next 12 months. If your turnover is expected to be, or was more than £230,000 (including VAT) then you must leave this scheme.

The Flat Rate VAT system changed in April 2017

Yes, everything changed for flat rate VAT in April 2017, which means that unless you purchase 2% of tangible goods per quarter (this cannot include services, and the ‘allowable’ goods you are allowed to purchase using this filter are extremely limited) then your flat rate VAT charge will be 16.5%

Since the changes to the flat rate VAT scheme, it is now being talked about as the ‘end of an era’ for businesses who enjoyed the previous benefits. A great write up can be found here:

https://www.accountingweb.co.uk/tax/business-tax/vat-flat-rate-scheme-end-of-an-era

Bascially, what HMRC are trying to do is ‘force’ everybody onto the 20% rate, because if you are flat rate and go for the 16.5% it means that you cannot reclaim any VAT on your outputs, and this together with only saving 3.5% (compared to the standard 20%) means it probably will not be worth your while anyway, and may as well be on the full rate and be able to reclaim all your VAT expenses.

HMRC are targeting low cost traders, internet types that have very little costs, and literally forcing them to pay the full VAT rate, rendering the flat rate scheme almost useless.

Should You Avoid VAT Registration?

Personally, unless you are running the type of business where you can easily add VAT to your existing prices, making no odds to the receiving party (another VAT registered business), then I would personally advise against registering for VAT for as long as is humanly possible.

The reasons are simple. VAT is effectively a stealth tax, packaged in a way that HMRC offer it as ‘being professional’. They even have courses about it where they try to convince you that it is a ‘genuine’ business expense.

vat washing machine repair shop

Why you should avoid VAT registration if your customers are not VAT registered also.

Consider the following:

Let’s say you are selling on eBay, or have a website selling a product, or even a service on the high street where you are competing with other rivals.

You sell a washing machine repair service in your local area. You advertise in your local papers to drum up trade, and are doing rather well. So much so that you are now approaching the VAT threshold, where you are ‘forced’ to register – under current HMRC rules. Not such a problem you might think.

  • You duly register with HMRC, and receive your freshly printed VAT registration certificate.
  • You add 20% onto your prices to cover your VAT liability, and continue running your business.

All of a sudden you start realising that you are not getting as many phone calls as you normally do, and you find that you are spending more and more time in your shop instead of actually out on the road fixing people’s washing machines.

You now start scratching your head as to what the reason could be for this lack of new business.

lost business VAT

What changed now that you are VAT registered?

It is quite simple, all your competitors that are not VAT registered can now easily undercut your pricing….

Eh?….that’s not right?! Yup, because you are now VAT registered and have increased your prices accordingly, all the other washing machine repair businesses who are not VAT registered can now keep their prices the same, whereas you have to increase your prices by 20%.

Think about it logically. Who would you choose as a customer? A cheaper provider/serviceman, or one who is now 20% more expensive than some of the others.

You have now been penalised by HMRC for being successful – Great eh  🙂

What can you do to solve this?

Not a great deal. You either do the following, and keep inline with your obligations:

  • Add the 20% to your prices
  • Absorb the 20% and take the hit on your profits

Not exactly fair is it? Your competition can now easily undercut your prices and there is not a single thing you can do about it.

VAT registration and eBay Chinese Sellers

This exact same scenario is being carried out on eBay multiple times a day. Especially now that many Chinese companies who advertise themselves as UK based are in fact operating from China, and bypass the VAT.

This is crippling UK sellers for the exact same reasons as I outlined with the washing machine example.

Read this report on the Guardian Newspaper which highlights the story:

https://www.theguardian.com/business/2016/nov/28/amazon-ebay-sellers-vat-fraud-ipads-tax-free

It is not just a problem with overseas sellers. The simple fact is that many UK businesses are now actively choosing to stay VAT free, by stopping trading once they hit the threshold.

Meaning, that if you yourself sell a similar line of goods and are registered for VAT, they can easily undercut you, and your sales will drop.

Chinese eBay sellers VAT avoidance techniques:

Many sellers from China actively advertise themselves as UK based, but products are sent from overseas marked as gifts, etc.

ebay china vat

VAT is also being applied to invoices from eBay, with sellers being forced to pay them whether they are VAT registered or not:

https://www.ft.com/content/805baf76-3710-11e7-bce4-9023f8c0fd2e

The above is also for personal items, like your old games console that you just wanted to make a few quid from by selling on eBay.

Put simply, for sellers on eBay, that unless you are selling unique items, or personalised products that are not easy to compete with, then once you hit the VAT threshold, your competition is going to have the upper hand, all courtesy of your friendly HMRC.

HMRC are, and have been clamping down on seller VAT ‘avoiders’ for many years,  but are now actively ramping up their activities.

What Can You Do To Avoid VAT?

Of course you can avoid VAT by not going over the threshold of £85,000 (2017 year), and restricting your sales accordingly. Many people do this –  as ludicrous as it sounds.

It really is crazy when you think about it; having to restrict your sales, or your profits are going to reduce anyway once you register, and then you are fighting for more sales just to basically stand still.

Many businesses, and products don’t even make a 20% margin on their bottom line, and thus have no option but to increase their prices to try and make a profit, which immediately puts them at a large disadvantage from their competitors.

Of course, as I mentioned above, if your customers are VAT registered (other VAT registered businesses) then it does not matter, because you would simply add the 20% to the invoice and they claim it back, but for a retail customer base it is not so easy to do this, for all the reasons outlined above.

If you are then reaching the VAT threshold, and are in a business that has a retail customer base, with competition, then you have a serious decision to make.

You either stop trading once you have hit the threshold, making accurate calculations that you can trade again at a certain point in the future (remembering that VAT is a 12 month period of threshold calculation  – not just in the current financial year), or you decide to register for VAT and take the risk.

If you feel that you can increase your sales volume moving forward sufficiently enough to warrant the 20% loss in profits, and increase sales enough to make additional profit, then the decision is already made for you.

Not many are in that position with a small business though, and it is now crippling many, many businesses who are either forced to register for VAT, and have to stop trading completely untill their sales are back under the VAT threshold.

Conclusion on Registering for VAT

It is not straight forward. As previously mentioned, if you are in a B2B (business to business) environment, then you can simply add the VAT ‘hit’ to your clients, who generally have no problem with this as they claim it back anyway.

If you are an eBay seller, own a website, or even a high street business with competition from other businesses that are not themselves VAT registered then you can have an issue, because you will be immediately undercut on prices = lost sales and revenue.

The current VAT system certainly hides any advantages very well,  whilst at the same time penalising many small businesses, and it is all packaged up as a legitimate way of doing business. HMRC even give ‘courses’ on it these days, as if they are somehow doing you a ‘favour’.

“Gee… Thanks for the extra tax/loss of profits, and for the free course to make it easier for me to hand it over to you…”

Basically it sucks, so my advice, and the majority of those business people I spoke to would be to be careful when approaching that VAT threshold and think VERY carefully about your next steps.

VAT is simply a stealth tax for many small businesses, and you simply do not make money by being VAT registered, you will never be able to claim back more than you pay over the long term, but it is a legal obligation, so you need to decide on what is best you your business – speak to your accountant also.

Above all, do your research and think carefully!

 

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