VAT for small businesses – what you need to know

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VAT or Value Added Tax is something we are all familiar with. We usually have to pay VAT when buying goods and services – it is added to the sale price by the supplier. As a small business owner (and therefore a supplier of goods or services) there are certain aspects of VAT that you need to be aware of. For simplicity, we will refer to the goods or services you produce as ‘product’ for the rest of this article.

VAT registration

The threshold for registering for VAT currently stands at an annual VAT taxable turnover of £85,000. This figure will change over time, and you should always check with the government VAT website for the latest information.

Input and Output VAT

In order to produce your product, you will use resources (i.e. goods or services) from one or more suppliers. Each supplier will charge VAT on these resources (unless they are exempt or zero rate – we will come to that later). The tax you pay on the resources to produce your product is called Input VAT.

When you sell your product, and you add value added tax to the sale price, this is called your Output VAT.

If you are VAT registered, you may be able to reclaim your input VAT. If your customer is VAT registered, and the product is purchased for their business, they may be able to reclaim the output VAT – your output VAT becomes their input VAT.

Rates of VAT

The rates of VAT vary depending on the type of product you are supplying. The government varies the rates from time to time, so it’s wise to check with the government VAT website for the latest information. Let’s look at the four different VAT rates and how they are applied.

Exempt and Zero Rate

On the face of it, exempt and zero rate sound like the same thing. In both categories, the product does not have any VAT added to the price, so the consumer sees no difference between the two. For the supplier however, there is a major difference.

Exempt product is effectively outside the VAT system. No VAT is added, but crucially, VAT registered businesses may not be able to reclaim input VAT (see above). Exempt product includes education supplies and health services from doctors and dentists, but not services from some complementary therapists such as osteopaths.

Zero rate product is within the VAT system, but the VAT rate is set at 0% In this case, VAT registered businesses can reclaim input VAT. Zero rate product includes children’s clothes and shoes, newspapers, books and food (excluding restaurant meals and take-aways).

Reduced Rate

Currently set at 5%, this rate covers home and charity power and fuel supplies.

Standard Rate

Currently set at 20%, but this may change from time to time. Basically, this rate covers everything that isn’t exempt, zero rate or reduced rate.

Record Keeping

As with anything to do with finance and tax, meticulous record-keeping is essential when it comes to VAT. It is very easy to fall foul of the rules and regulations. For example, £85,000 turnover sounds like a high figure, but it is turnover, not profit. If you are in a seasonal business, you may end up with a spike in turnover in your largest season (e.g. Christmas) and failing to register for VAT at the right time can be a costly error.

Most businesses can benefit from outside help when it comes to accounting and record-keeping. Don’t struggle on your own – call in the experts, and you can get on with running your business while someone else looks after the VAT.


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