How does VAT work, and what do you actually need to know?

If you’re looking at this, then you probably already have an idea of what it’s all about, but if you’d like to know more, you’re in the right place.

Value Added Tax (VAT) is a consumer tax that is included in the price of goods or services rendered. It is an additional layer of accountability to the tax authorities, as it has to be remitted and not be considered as an extra income for a business.

VAT rates vary in different countries, currently, in the UK, the standard rate is 20%. However, some exceptions offer a reduced rate and others charge zero VAT. (QuickBooks has a great article on VAT rates, here).

So, how does VAT work?

Your business must be registered for VAT with HMRC if the taxable turnover exceeds £85,000.

If your business sells goods and services that are taxable (either 20% or at the reduced rate), it should calculate the VAT turnover (based on the value of taxable supplies) over a rolling 12-month period.

Exempt goods refer to items that one cannot charge VAT on. If your business trades items that are exempt from tax, it does not need to be registered for VAT. However, the sale of VAT-exempt items still needs to be recorded for your business.

Your responsibilities as a VAT-registered business owner

All VAT-registered businesses are required to submit a VAT Return to HMRC.

The VAT Return documents the amount of VAT the business charged on sales and paid on goods and services procured. Companies that are registered for VAT must submit a VAT Return either monthly, quarterly or annually – this period is commonly referred to as the 'VAT accounting period'.

From the moment a business becomes VAT registered, the owner must ensure that:

  • The correct amount of VAT is charged
  • Pay VAT that's due to the HMRC
  • Submit VAT Returns
  • Keep a record of all business transactions

During the process of registering for VAT, the business owner is not allowed to charge VAT nor indicate VAT on invoices until a VAT registration number is received. However, VAT will still need to be paid to the HMRC for this period. As a business owner, you can increase the price of your goods and services to cover the costs of paying VAT owed to HMRC. Make sure that you explain this to your customers. Include a simple note on the invoice such as “VAT registration is pending; an invoice will be reissued to include VAT”. This will inform your customers that the invoice will be reissued at a later date to include VAT.

Pro-tip*: Ensure that your paperwork is without fault by appointing an accountant to handle your business transaction records. This gives you more time to focus on running your business and you’ll avoid penalties.

If you're struggling to wrap your head around how VAT works, or simply do not have the time to focus on it, get in touch with us at Holistic Financial Group - we can help with the admin-heavy side of your business.