Value Added Tax (VAT) is a general tax that is placed by businesses onto the goods and services they provide. VAT is calculated depending on the cost of the item and is percentage based meaning the costlier the product or service the higher the rate of VAT. In this article we explain how VAT works and when and how your business should pay it.
How does VAT work?
VAT is charged on products and services that are ‘taxable supplies’, such as business sales, commission or business assets.
Businesses are required to charge VAT once their business enters certain tax thresholds determined by the government and any profits on goods and services after this threshold will be charged VAT. For the 2021/22 tax year, the VAT threshold was £85,000. This means that all businesses with a taxable turnover that exceeds £85,000 will need to:
- Register for VAT with HMRC
- Charge VAT to customers on your taxable goods and services
- Set aside VAT
- Account for VAT on their tax returns and pay it back
If you fail to register for VAT when you enter the threshold your business will face penalties and investigations.
VAT rates
Once you have determined that your business must charge VAT, you will need to identify what of the three rates of VAT applies to your business:
- Standard rate: the most common rate that the majority of businesses charge and pay
- Reduced rate: this applies depending on the nature of the sale and the product. For example, children’s car seats and domestic power are charged at 5% VAT. If you think you should be paying a reduced rate you should get in touch with HMRC
- Zero rate: products and services that fall under this category will still be VAT-taxable but the rate of VAT is 0%. This category includes children’s clothing and newspapers.
Your business might operate with a variety of VAT rates for different products and services it offers. It is crucial that you record the VAT of all products, even those that are charged at 0%, on your tax return.
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Making Tax Digital
Your business must also follow the rules for ‘Making Tax Digital for VAT’. This means that unless you’re eligible for exemption or using the VAT GIANT service (which applies to government departments and NHS trusts) you must keep some of your records digital.
What does it mean to keep your tax digital?
In order to keep digital records you must use a compatible software package or similar software (such as spreadsheets) that are connected to HMRC systems and if using multiple systems these must be linked.
You must have this software in place before you sign up to Making Tax Digital. For businesses to sign up, you need a business email address, Government Gateway log in details, your VAT number and your latest tax return. Depending on the nature of your business, you will also need other numbers and reference codes. For example, if you are a sole trader you will need to present your National Insurance number and if you are a limited company you will need to supply your company registration number and Unique Taxpayer Reference.
You can sign up for Making Tax Digital here and you should receive a confirmation email within 3 days of submitting the relevant information. You must wait until you receive a confirmation email from HMRC before submitting a VAT Return.
What records must you make digital?
You must keep several records digital once you have registered for Making Tax Digital. These include:
- Information relating to your business including your business name, address and VAT registration number
- VAT accounting schemes used and any takings made on those schemes (for example a retail scheme, a Flat Rate Scheme or Gold Accounting Scheme )
- VAT on supplies made and supplies received, including the time of supply and value of supply (excluding VAT)
- Adjustments made to your tax return
- Any reverse charge transactions
- Any takings your receive
Alongside these details you also want to ensure that you are keeping copies of any multiple transactions that are made on behalf of your business. For example, any volunteers involved in charity fundraising or employees dealing with expenses in petty cash.
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The opinions on this page are for general information purposes only and do not constitute legal advice on which you should rely.