Do Businesses Pay VAT? Charging and Reclaiming VAT as a UK Business

VAT is often seen by many business owners as an additional cost to the business, but this is not always true. In general, VAT-registered businesses collect VAT on taxable supplies made to customers, pay the amount collected to HMRC after deducting eligible input tax, and reclaim input VAT incurred on their own purchases. VAT is a cost to the business when it makes exempt supplies, cannot recover its input VAT, or is subject to a restriction on VAT recovery.

Failing to comply with VAT rules and deadlines can lead to penalties and interest. This guide discusses the registration process, how businesses charge VAT, the reclaim process, and common mistakes made by business owners.

Do businesses pay VAT? The direct answer

From an accounting perspective, output VAT, which businesses charge on their taxable sales, is not a cost to the business in the way Corporation Tax and National Insurance are. However, they charge output VAT to their customers and then remit it to HMRC, while reclaiming eligible input VAT on their business purchases and expenses. Usually, the total amount of VAT that a business remits to HMRC is the balance between the VAT received from customers and VAT reclaimable on eligible business purchases. The confusion is because money flows in both directions:

• Money collected from customers as output VAT, before paying it over to HMRC.
• VAT paid to suppliers on the purchase of goods, equipment or services, which is recoverable as input VAT.

At the end of every VAT accounting period, output VAT and input VAT are compared to work out how much VAT a business must pay to HMRC or reclaim from HMRC.

Businesses pay VAT on the items purchased. They charge VAT on the sales made and account to HMRC for the difference between output VAT and input VAT.

When the business cannot claim back all the VAT it has paid, VAT becomes a genuine cost to the business. This happens when a business makes exempt supplies, has personal use of items it has purchased, or is subject to restrictions on input tax.

Not every business is in the VAT system.

Firms which are not VAT-registered, including firms below the compulsory registration threshold but not registered voluntarily, generally do not charge VAT on their taxable supplies nor reclaim VAT on their expenses. As a consequence, VAT payable to suppliers typically forms part of their cost structure. Firms which make exempt supplies are also subject to different rules in terms of registration and recovery of input VAT.

VAT rates that apply to sales

HMRC currently uses three VAT rates for taxable supplies:

• Standard rate, 20%, for most goods and services.
• Reduced rate, 5%, for specific goods and services, which include domestic supplies of energy and children’s car seats.
• Zero rate, 0%, for particular goods and services, including most food products and young children’s clothing and footwear.

Zero-rated supplies are taxable supplies for VAT purposes even though the VAT rate is 0%. This means that usually the firm can still reclaim input VAT in respect of those supplies.

For exempt supplies, the situation is different as VAT is not charged on exempt supplies, while the input VAT connected with exempt activities cannot be reclaimed under the partial exemption rules.

When registration becomes compulsory

A business must register for VAT if its taxable turnover exceeds £90,000 over the last 12 months, or if it expects its taxable turnover to exceed £90,000 in the upcoming 30-day period. The threshold considers taxable turnover, and not turnover in general, and it is not based on either financial or tax years. Here are a few things you could do to manage this:

1. Calculate your taxable turnover for the last 12 months on a rolling basis.
2. Compare this figure with the £90,000 registration threshold.
3. When you exceed the threshold under the previous-12-months test, inform HMRC within 30 days of the end of the month in which the threshold was exceeded.
4. Your effective date of registration is normally the first day of the month that falls two months after you exceed the threshold. Other dates apply if you expect to exceed your threshold in the next 30-day period.

Businesses that choose to register themselves voluntarily below the threshold can use this opportunity to recover their eligible input VAT. Some businesses register voluntarily because of their customers, their costs, or other commercial reasons. A business can ask HMRC to cancel its VAT registration if its taxable turnover falls below £88,000.

The mechanics of charging VAT

Applying VAT correctly is more than just calculating the VAT charge. Businesses have to determine the right VAT treatment for the sale, issue a VAT invoice where required, and keep records to support their VAT calculations.

VAT addition process for a sale

• Calculate the net sales price excluding VAT.
• Determine whether the goods or services are standard-rated, reduced-rated or zero-rated.
• Calculate the VAT based on the rate applicable for the transaction.
• Show the VAT separately on the VAT invoice where required.
• Record the transaction and include the relevant output VAT in the VAT return.

Some companies can apply zero-rating when they export goods or make some cross-border supplies. But there are certain conditions and evidence that must be obtained and retained. Different VAT treatments can apply depending on the kind of transaction and the location of the customer or goods, so companies cannot treat all their overseas supplies as zero-rated.

Situations where VAT is not added

A VAT-registered trader will not necessarily levy VAT on all transactions. For instance:

• Where the supply is exempt from VAT. Certain supplies of insurance, financial, education, and healthcare services, among others, qualify depending on the specific exemption.
• Where the supply is entirely outside the scope of UK VAT. Certain transactions cannot be brought within the VAT regime in the UK.

The absence of VAT on an invoice does not automatically mean the transaction is exempt. Proper records must be kept explaining why no VAT was charged.

Recovering VAT on business spending

Input VAT is the VAT paid by a business for eligible goods and services. Reclaiming input VAT can help reduce the VAT bill of a business.

What normally qualifies

• Qualifying purchases for which VAT may be recovered, evidenced by a proper VAT invoice.
• The share of business use for an expenditure where a resource has been used for business and personal purposes. The share of VAT that you can recover depends on the degree of business use of the resource.
• Certain expenditures made prior to the registration for VAT. You can usually claim back VAT on qualifying goods purchased within four years before registration and qualifying services purchased within six months of registration.

Where reclaims are restricted

• Any VAT related to exempt supplies can normally be treated under the partial exemption rules and may therefore not be recoverable in full.
• A trader who operates under the Flat Rate Scheme will normally be unable to reclaim any VAT on its purchases, except for certain capital expenditure goods bought as a single purchase costing £2,000 or more, including VAT.
• There are special rules that apply to vehicles such as cars when recovering the VAT paid on purchases. In general, input VAT on a vehicle can usually be recovered in full depending on various conditions, including whether it’s used exclusively for the business.

There are different rules where a business buys commercial vehicles, leases them or buys their fuel.

Working out what actually gets paid or refunded

Each VAT period, HMRC looks at the amount of output VAT payable against the input VAT reclaimable and decides whether there is any VAT to pay or refund.

Record Keeping Requirements

There is an obligation on VAT-registered companies to maintain proper VAT records, which include invoices and the VAT account. VAT-registered businesses supplying goods or services that are both taxable and exempt may be required to maintain proper records of input VAT allocation and calculation through the partial exemption method.

The requirements of Making Tax Digital for VAT include keeping electronic records and submitting VAT returns via compatible software. Businesses are required to satisfy HMRC record-keeping and submission requirements to avoid penalties.

Common mistakes worth avoiding

Apply wrong VAT rates.

If you are not careful to apply the correct VAT rate, you can make incorrect invoices and VAT returns. The process of rectifying mistakes can take time, and there can be additional VAT liabilities as well.

Losing track of the rolling threshold

£90,000 VAT registration threshold is based on taxable turnover over a rolling 12-month period rather than a tax year or accounting year. Therefore, if a company grows fast, it needs to monitor its taxable turnover closely.

Reclaiming VAT that is not eligible

It can happen that businesses wrongly assume that all input VAT related to their purchases can be claimed back. Input VAT that cannot be reclaimed due to exemptions for some activities, private use, partial exemption and the Flat Rate Scheme is one example of that situation.

Choosing a wrong VAT scheme

As previously noted, the Flat Rate Scheme provides a simplified method of VAT calculation for those businesses who qualify for it. However, the Flat Rate Scheme usually does not allow claiming any VAT incurred on purchases made by a business. This makes it unsuitable for businesses which have lots of VAT-related costs. But still, qualifying capital expenditure items purchased for more than £2,000 excluding VAT can allow claiming input VAT.

The bottom line on business VAT

And now, the question is: do businesses pay VAT? In general, VAT should not be treated as an expense for a VAT-registered business selling taxable supplies. A business collects VAT from customers, pays VAT on its own purchases and remits the difference to HMRC. But sometimes VAT becomes an actual cost when no input tax can be claimed back.

How Reflex Accounting can help

Registering for VAT, the VAT schemes selection and optimising your reclaim of input VAT are just some of the key considerations that should be made from the outset when working with HMRC. Particularly when changes in your turnover take place. Reflex Accounting can help you handle all the compliance burden by ensuring that all the VAT decisions have been made from the very outset.

• Monitoring taxable turnover against the £90,000 threshold and completing VAT registration with HMRC.
• Suggesting the most suitable VAT scheme for your business, such as Standard VAT Accounting, Flat Rate or Cash Accounting.
• Implementing VAT-compliant systems as required under the Making Tax Digital programme.
• Preparing and submitting VAT returns.
• Reviewing purchase invoices to reclaim legitimate input VAT.
• Advising on correct VAT treatment of zero-rated, exempt and partially exempt supplies.

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