If you are a sole trader, then keeping on top of your VAT (Value Added Tax) commitments is crucial for ensuring that you manage your business in the best possible way. VAT registration is compulsory for businesses with a turnover above the threshold, however, it can also be voluntary for companies that might benefit from potential rewards.
In this post, we will cover the situation where VAT registration is compulsory and how it works as well as the advantages and disadvantages of voluntary registration. We also talk about what you should do if you have multiple businesses and review how to workflow or manage your VAT responsibilities as a sole trader.
Understanding VAT registration requirements
HMRC will insist sole traders need VAT registration when their taxable turnover is above the VAT registration threshold. Currently, the threshold is £90,000 for any 12-month rolling period. This effectively means that if your business’s total VAT-taxable sales (including zero-rated and exempt supplies but excluding any non-business income) have exceeded £90,000 over the last 12 months, then you must register for VAT.
The sale of goods and the supply of services taxable under VAT is, therefore, a turnover subject to tax, while exempt transactions (like financial operations) or times falling outside the scope of EU law regulations should be disregarded. Once your turnover exceeds this limit, you must register in 30 days or face penalties that can end up with fines and interest on late VAT. Taking necessary measures to watch your turnover in advance helps you prevent fines and comply with VAT norms.
How does VAT work?
VAT is a consumption tax levied on selling goods and services in the UK. It is applied at various supply chain stages, from production to the final consumer. Businesses act as VAT collectors for HMRC, charging VAT on sales and reclaiming it on purchases. Here’s how it works:
VAT rates
The UK has three VAT rates:
- Standard rate (20%) – This is a more general VAT; hence, the 20% Standard Rate applies here, and it refers to most goods and services that do not fall within other categories.
- Reduced rate (5%) – For some products such as home energy or children’s car seats.
- Zero rate (0%) – This covers items like most food, children’s clothes and books. However, while there is no VAT charged on these items, businesses selling zero-rated goods can still reclaim any VAT they have paid out for business expenses.
Output tax (VAT on sales)
A VAT-registered business that sells goods or services charges its customers output tax. This is then added to the sale price. If you sell a product, e.g. £100 subject to standard VAT, the amount will be £120 (£180 plus £20 VAT). In the end, VAT is paid for by the customer, but it’s up to a business to collect and pass that on as they will have to account for and pay over any themselves.
Input tax (VAT on purchases)
Businesses can reclaim the VAT they have paid themselves on costs and expenses, i.e. input tax. For example, if you buy materials for £50 plus another £10 in VAT, that can be claimed back. The aim is to ensure that businesses are not taxed on the same value more than once.
VAT returns
VAT-registered businesses must file regular VAT returns with HMRC, usually every quarter. These returns outline the VAT on sales (output tax) and the VAT you paid on acquisitions (input tax). If the VAT you are due from sales is more than what you paid on purchases, then that difference must be given to HMRC. If the input tax is bigger than your output tax, you can ask to get the VAT back.
VAT exemptions
Financial services, property transactions and education are among the goods or services that do not attract VAT. Suppliers of goods or services that are exempt from VAT cannot charge VAT on their sales or reclaim it on related expenses, which affects their cost structure.
VAT schemes
There are several schemes designed to simplify VAT for small businesses:
Flat Rate Scheme: Rather than paying VAT on all transactions, businesses pay a percentage of their turnover to reduce administrative costs.
Annual Accounting Scheme: Businesses are able to pay their VAT in instalments, and only one annual return needs to be filed, not quarterly returns.
Cash Accounting Scheme: VAT is accounted for as being paid when invoices are settled, instead of when they were raised which is useful to manage your cash flow.
Voluntary VAT registration for sole traders: The pros and cons
Sole traders whose taxable turnover is below the £90,000 VAT threshold are not required to register for VAT. However, voluntary VAT registration is an option and can offer benefits, though it also comes with some drawbacks. Let’s explore the pros and cons of voluntary VAT registration for sole traders.
Pros:
- Reclaim VAT on business expenses: You can claim back VAT on eligible expenses, reducing your overall costs, especially if you make large purchases.
- Enhanced credibility: VAT registration can make your business seem more professional and established, appealing to larger clients.
- Improved cash flow options: Access to schemes like the Flat Rate or Cash Accounting Schemes can help streamline cash flow management.
Cons:
- Increased admin work: Registering adds extra paperwork, including quarterly returns and detailed record-keeping, which can be time-consuming.
- Potential price increases: Charging VAT may raise your prices by up to 20%, potentially making you less competitive for non-VAT registered customers.
- Negative customer perception: Non-VAT registered customers may dislike the extra VAT cost, especially individuals or smaller businesses who can’t reclaim it.
How do I charge VAT as a sole trader?
If you are a sole trader and have completed registering for VAT, then you must add 20% to every sale of your taxable goods and services. The normal VAT rate is 20%, however, a few items are subject to decreased rates (5%) or none at all.
You add the appropriate percentage to your goods or services and give a VAT invoice that shows how much you have charged in tax. You then pay this VAT to HMRC as part of your regular VAT returns. In order to properly record and report VAT, you must keep track of all your sales/income as well as purchases made.
Special considerations for sole traders with multiple businesses
VAT registration for sole traders running several businesses, within a similar trade or industry, is based on the aggregate turnover of all their businesses. So, suppose HMRC treats these enterprises as linked for VAT purposes (and you have a turnover from all companies of over £90,000). In that case, they will say that everything crosses the registration threshold and, therefore, becomes standard-rated. This would make accounting even more complex, especially if the entrepreneurs were from different industries and regions with varying rates of VAT.
Additionally, if a business is required to charge VAT on all sales, this may affect the ability to price and meet customer expectations. Given the complexities, it is of immense importance that you should never rely on your personal judgement and take professional help to ensure proper VAT compliance and management.
Conclusion
In conclusion, VAT registration is a significant consideration for sole traders, whether due to exceeding the £90,000 turnover threshold or opting for voluntary registration. Understanding how VAT works, including its impact on pricing and administrative requirements, is crucial for managing your business effectively. Sole traders with multiple companies must know how combined turnover affects VAT obligations.
Consulting with an accountant is highly recommended for tailored advice and ensuring compliance. At Reed & Co Accountants, we offer expert guidance to help you navigate VAT registration and its implications, ensuring your business remains compliant and efficient.