Value Added Tax (VAT) is a tax on the supply of goods and services in the UK and across the European Union. It is an indirect tax that is charged as a percentage of the price of the goods or services being supplied. VAT is mandatory for businesses that meet certain thresholds in the UK.
What is VAT?
VAT stands for Value Added Tax. It is a tax that is charged on most goods and services that are bought and sold for use or consumption in the UK. It is not a tax on companies – it is a tax on transactions and ultimately paid by the final consumer of the product or service.
VAT is an indirect tax and is charged as a percentage of the price of the product or service. The standard rate of VAT in the UK is currently 20%. There are also reduced VAT rates of 5% for certain goods such as domestic gas and electricity and 0% for certain essential items such as most foods, books and children’s clothing.
VAT is collected by VAT-registered businesses at every stage of the supply chain. However, the VAT paid on inputs can be claimed back from HMRC. This means that the eventual burden of the VAT falls on the final consumer.
Is VAT registration mandatory in the UK?
VAT registration is mandatory for businesses that meet certain VAT thresholds in the UK. The main VAT thresholds are:
- The taxable turnover threshold – Currently £85,000 per year. Businesses must register for VAT if their taxable turnover (excluding VAT) exceeds this threshold.
- The non-taxable turnover threshold – Currently £1.35 million per year. Businesses must register for VAT if their total turnover exceeds this threshold, even if their taxable turnover is below £85,000.
- The distance selling threshold – Businesses selling goods from abroad to UK consumers must register for VAT in the UK once they exceed the distance selling threshold, which is currently £70,000 of sales to UK consumers.
There are some other situations in which a business may need to register for VAT even if it is below the thresholds. These include:
- Making taxable sales to other EU countries
- Purchasing goods from EU suppliers over £85,000 per year
- Certain business reorganisations
But in general, VAT registration is only mandatory if the business turnover exceeds the thresholds. Businesses can also voluntarily register for VAT even if they are under the thresholds if they want to reclaim VAT on purchases.
What are the VAT registration thresholds?
The main VAT registration thresholds in the UK are:
- Taxable turnover threshold – £85,000 per year
- Non-taxable turnover threshold – £1.35 million per year
- Distance selling threshold – £70,000 of UK sales
If a business exceeds any of these thresholds, it must register for VAT with HMRC. The taxable turnover threshold is the main one that determines if VAT registration is mandatory. If taxable turnover exceeds £85,000 (excluding any VAT charged) then the business must register.
Taxable turnover includes all sales of standard or reduced rated goods and services. It does not include sales that are exempt from VAT, such as financial services, insurance and rental of commercial buildings.
The non-taxable turnover threshold takes into account all business sales, including VAT exempt ones. So if total turnover exceeds £1.35 million, the business must register for VAT even if taxable turnover is less than £85,000.
The distance selling threshold applies to overseas businesses selling goods to UK consumers. If UK sales exceed £70,000 then the overseas business must register for VAT in the UK.
What are the consequences of not registering for VAT?
There can be serious consequences for businesses that are required to register for VAT but fail to do so. The main potential consequences include:
- Having to pay HMRC the VAT that should have been charged – The business will have to calculate and pay over the VAT that should have been charged and paid if it had been VAT registered.
- Penalties and interest – HMRC will charge penalties and interest on the late paid VAT. Penalties can be up to 100% of the VAT due.
- Bad debt relief claims denied – Businesses cannot claim bad debt relief for invoices on which they should have charged VAT but did not.
- Higher costs – The business will have higher costs as it cannot recover VAT on purchases.
- Reputational damage – Customers and suppliers may lose trust in a business found to be non-compliant on its taxes.
Therefore, it is strongly recommended that businesses register for VAT on time if they exceed the VAT thresholds. The penalties for non-compliance can be severe.
How does the VAT registration process work?
The process for registering for VAT in the UK is relatively straightforward. Here are the steps involved:
- Find out the date from which VAT registration is required – This is important as registration may be required from an earlier date than when the application is made.
- Gather information needed for the application – Including business address, business activities, bank details, accounting details, expected taxable turnover etc.
- Apply online – Most applications are made online via the HMRC website. Alternatively a VAT 1 form can be filled out.
- Receive VAT registration confirmation – HMRC will send a VAT registration certificate usually within a few working days.
- Start using VAT on sales invoices – Once registered, VAT must be charged on all taxable goods and services.
- Submit regular VAT returns – Registered businesses must submit VAT returns, usually quarterly. VAT collected must be paid over, less VAT on business purchases which can be reclaimed.
The online VAT registration process takes around 10-15 minutes. HMRC will carry out checks and issue the VAT registration number if everything is in order. It is advisable to apply in good time before VAT registration is mandatory.
Who needs to register for VAT?
The main categories of businesses that need to register for VAT are:
- UK businesses with taxable turnover over £85,000 – This is the main VAT threshold. UK businesses trading in goods or standard-rated services must register if turnover exceeds this.
- UK businesses selling at distance to EU consumers over £70,000 – This includes online and mail order sales from the UK to EU countries.
- UK businesses with total turnover over £1.35 million – Even if taxable turnover is less than £85,000.
- Businesses making sales to VAT registered customers in EU – This can require VAT registration even if under the UK thresholds.
- Businesses purchasing over £85,000 per year from EU – This may require a business to register in order to reclaim import VAT.
In addition, businesses can choose to register voluntarily for VAT even if below the VAT thresholds. So in summary, VAT registration is mandatory for businesses once they exceed the turnover thresholds but can also be voluntary.
How much does it cost to register a business for VAT?
Registering for VAT in itself does not cost anything – there is no fee payable to HMRC to register. However, there are some indirect costs involved in becoming VAT registered. These include:
- Staff costs – More admin time is needed to run VAT accounting, prepare VAT returns and deal with VAT inspections.
- Accounting fees – Many businesses use an accountant to help with VAT compliance, which comes at a fee.
- Software costs – Most businesses use dedicated VAT software to manage VAT records and returns.
- Training – Staff may need training to understand VAT rules and implement VAT accounting processes.
- Extra tax liability – For some businesses, VAT registration can increase overall tax paid due to the inability to reclaim VAT on purchases.
Overall, the additional annual costs from VAT registration can range from a few hundred pounds for very small businesses doing it themselves to thousands of pounds for larger businesses using accountants and software.
How much extra work is involved in VAT accounting?
Complying with VAT does involve some extra work for businesses. The main additional tasks include:
- Issuing VAT invoices for all taxable sales
- Keeping digital records of all sales and purchase invoices
- Entering VAT transactions into accounting software
- Checking VAT calculations and ensuring the correct VAT rate is applied
- Reconciling VAT control accounts
- Completing and submitting quarterly or monthly VAT returns
- Making VAT payments to HMRC
- Handling VAT inspections by HMRC
For very small businesses doing everything manually, this may add a few hours of work each month. For larger businesses, most of the VAT accounting is automated using software and outsourced, but there is still some additional management time required.
Having an accountant or bookkeeper handle VAT compliance can reduce the extra workload for the business owners themselves. But overall VAT does mean additional accounting work compared to not being registered.
What are the benefits of VAT registration?
Although VAT registration does come with additional obligations, there are also some benefits:
- Ability to reclaim VAT on purchases – This reduces costs for many businesses buying a lot of taxable goods and services.
- Increased credibility – Being VAT registered can make a business seem larger and more credible to customers.
- Access to more customers – Some businesses prefer to deal with other VAT registered suppliers.
- Encourages good record keeping – VAT requires detailed digital records which can improve overall business accounting.
- Gain input tax – Businesses can charge VAT on sales but offset it against VAT paid on expenses.
- Automatic right to deduct VAT – VAT registered businesses have an automatic right to reclaim VAT without having to prove it relates to taxable supplies.
Therefore, although VAT registration has downsides, for many businesses the benefits of being able to reclaim VAT on costs can outweigh the additional burdens of compliance.
How to cancel VAT registration?
If a business wants to cancel its VAT registration, perhaps because turnover has fallen below the VAT threshold, it must follow the correct process:
- Check eligibility to deregister – The business must have been under the VAT threshold for the past 12 months and expect to remain under.
- Inform HMRC – Complete form VAT7 online to inform HMRC you wish to cancel VAT registration.
- Confirm cancellation date – HMRC will confirm in writing the last day of VAT registration.
- Remove VAT from sales – VAT should no longer be charged on sales after the confirmed cancellation date.
- Submit final VAT return – A final VAT return must be completed up to the last day of registration.
- Pay any outstanding VAT – Any remaining VAT must be paid.
- Keep records – Records relating to VAT must be kept for 6 years after deregistration.
Cancelling VAT can provide simplification and cost savings for small businesses. However, businesses should ensure they are eligible to deregister before starting the cancellation process with HRMC.
Conclusion
VAT registration is mandatory in the UK for businesses that exceed certain VAT turnover thresholds. This includes taxable turnover over £85,000 per year, total turnover over £1.35 million, and UK distance sales over £70,000.
There are penalties for businesses that should register for VAT but fail to do so. However, VAT registration also comes with benefits such as being able to reclaim VAT on purchases.
Registering for VAT in the UK is a relatively simple process that can be done online via the HMRC website. Although VAT accounting does create extra work, software helps to automate much of this administrative burden.
Overall, VAT plays an important role in the UK tax system and businesses that reach the turnover thresholds need to ensure they are compliant with VAT rules and registration requirements.