What is the VAT threshold and when do you need to register for VAT?
A small business guide to valued added tax (VAT), voluntary and compulsory VAT registration, the VAT threshold and the different rates to be aware of
VAT is a tax charged by VAT-registered businesses on most goods and services in the UK.
It is also charged on goods and some services that are imported from outside the European Union (EU) and brought into the UK from other EU countries.
If a VAT-registered business is charged VAT when it buys goods or services, it can generally reclaim the VAT it has incurred. If the entity is not VAT-registered, then normally it cannot recover VAT it is charged.
People often refer to VAT-registered businesses as mini tax collectors. They charge customers VAT on top of their sales price, collect the cash and then pay it over to HM Revenue & Customs – minus any VAT they've incurred on their purchases.
A common question for business owners is do I need to register for VAT? And the answer depends on turnover, as well as a number of other factors, detailed below.
When do I need to register for VAT
What is the VAT threshold (compulsory VAT registration)
A business must register for VAT if its taxable turnover for any consecutive 12-month period exceeds the VAT registration threshold. The current VAT registration threshold (from 1 April 2017) is £85,000 but this tends to increase every year.
In 2016, the rate was £83,000 and this has been rising steadily over the last 10 years (from £64,000 in 2007) so make sure you check for the up to date rate.
Another common reason why a business may be forced to register for VAT is if it takes over an existing business that is VAT-registered. The test is if the taxable turnover of the purchaser for the last 12 months added to the turnover of the business being purchased is over the VAT registration threshold – if the answer is yes, then the business is obliged to register.
There is also an obligation to register for VAT if you think your business' turnover will exceed the threshold within just 30 days, but for most businesses, this would not apply. There are other scenarios when VAT registration becomes compulsory, for instance if you are trading outside of the UK.
Failure to register on time may lead to late registration penalties and/or ‘failure to notify' penalties. What's more, surcharges and interest are likely to be charged for late payment if the business has a VAT liability. If your business' turnover exceeds the VAT threshold temporarily, you can ask HMRC for an exception from registration.
Voluntary VAT registration
If the taxable turnover of your business does not exceed the current VAT registration threshold, you can still register for VAT voluntarily.
There are two main reasons why a business might opt to register for VAT:
- Customers are predominately other VAT-registered businesses and therefore any VAT they are charged can be recovered, so it makes no difference to their customers whether they are VAT registered or not
- They are often in a refund position with HMRC, so the business is actually better off being VAT registered.
Who cannot register for VAT?
An entity cannot register for VAT if it does not meet the definition of a business as stated by HMRC for VAT purposes.
A business is also prohibited from registering if it tends to sell only goods or services that are exempt from VAT.
Always consider the customer when registering for VAT…
Let's explain the first point in more detail, using a retailer as an example:
If a retailer's customers are generally other VAT-registered businesses, they will not mind whether they are charged VAT, because they can obtain a refund from HMRC.
So the business is probably better off registering for VAT because it can recover the VAT on its purchases. And this tactic isn't at all risky or dishonest – it's estimated that around 20% of all VAT-registered businesses trade below the VAT registration threshold.
However, if a retailer's customers are the general public (who are not VAT-registered), then they cannot recover the VAT. Therefore, the VAT is an additional cost to the public and inflates the retail price, so think carefully about whether you have to charge VAT. If the retailer's rivals are not VAT-registered, its prices won't be as competitive.
The different VAT rates
To illustrate point two, let's look at the different categories items fall into for VAT purposes:
|Name||Current rate||Description and examples|
|Standard||20%||The standard rate of VAT is the default rate – this is the rate that's charged on most goods and services in the UK unless they're specifically identified as being reduced or zero-rated.|
|Reduced||5%||Domestic fuel and power, installation of energy-saving materials, sanitary hygiene products, children's car seat, etc.|
|Zero||0%||Food (not meals in a restaurant or hot takeaways though), books/ newspapers, children's clothes/ shoes, public transport etc.|
|Exempt||Not applicable||The law stipulates that VAT exempt goods or services must not have any VAT charged on them. Examples include insurance, providing credit, education, fundraising, membership, etc.|
|Outside the scope||Not applicable||Items that are completely outside of the UK VAT system. Examples include drawings, wages, MOT tests, rates, etc.|
Farming is an industry where VAT refunds often occur. Their direct purchases are mostly zero-rated and so are their sales. However, any VAT they incur on other expenses such as overheads or equipment can be recovered – hence the refund position.
Other examples of businesses that may wish to register for VAT voluntarily might include a green grocers or a children's shoe shop. Again, their sales and direct purchases will generally be zero-rated, however, if they incur any overheads, legal fees or equipment, they should be able to recover any VAT they've been charged on these purchases.
Choosing a VAT scheme
Once you've established when to register for VAT, you'll want to consider the most appropriate VAT scheme for your business. There are three main options:
VAT flat rate scheme
This is only eligible for businesses with less than £150,000 (of taxable turnover – this is the total of everything you've sold that isn't VAT exempt). The scheme is designed to make record keeping more simple for small businesses by allowing you to apply a fixed-rate percentage to turnover, dependent on industry.
For more detailed information from HMRC, click here.
VAT cash accounting scheme
Another popular choice for start-ups and small businesses (turnover must be less than £1.35m), in this scheme you only have to pay VAT on your sales once you have received payment from your customers. Likewise you only reclaim VAT on any purchases you make once you have paid your supplier.
Typically, outside of this scheme VAT payments are due to HMRC regardless of whether your invoices have been paid yet, which can cause cashflow issues.
You cannot use the cash accounting scheme in conjunction with the VAT flat rate scheme.
Annual accounting scheme
Rather than filing your return each quarter, this scheme allows businesses to submit one annual return, as well as making advance payments (using estimated amounts based on the previous year's return) throughout the year.
Once you've completed your return, you can then either make a final payment (to cover any shortfall between your advance payments and the final bill) or apply for a VAT refund if you've overpaid.
For more information on VAT registration, check out part two of this guide: How to register for VAT
Jo Nockels is training and communications manager at TaxAssist Accountants.
TaxAssist Accountants: This article is intended to inform rather than advise and is based on legislation and practice at the time. Taxpayers' circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this article, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.