HOW VAT AFFECTS YOUR BUSINESS

Do I need to register my business for VAT?

It depends on your turnover. If you are in business making taxable supplies (i.e. not exempt from VAT) then the total value of these supplies is called your taxable turnover. Note: supplies exempt from VAT, or outside its scope, do not form part of the taxable turnover, but supplies that are charged at a zero rate are included.

If at the end of any month:

• (a)The value of your taxable turnover during the past 12 months has exceeded £61,000, OR
• (b)you have reasonable grounds for believing that the value of the taxable supplies you will make in the next 30 days will exceed £61,000

then you must register your business for VAT purposes.

You have to notify the Customs & Excise VAT Office that your business has exceeded these limits within 30 days of the end of the month. The registration will then take effect from the first day of the second month following that date (e.g. if your taxable turnover in the last 12 months up to the end of January is over the limit, your date of registration will be 1 March). The easiest way to notify them is to use the National VAT help line. The number is 0845 010 9000.

If you take over an existing business then you must take account of the level of taxable turnover under the previous owner and the date of registration will be the day the business was transferred.

If your turnover is below the limit for compulsory registration you can still apply to register for VAT if you think it will be an advantage. For example, you may be selling to other businesses which are themselves registered for VAT. By registering your own business you will be able to get the input tax back on your purchases; although you’ll have to charge VAT to your customers they will, of course, be able to get it back, too. If you are buying and selling only zero-rated goods you can still register, so as to reclaim the input tax charged on your expenses (e.g. motor expenses, telephone, professional fees, etc.).

What if I have more than one business?

Remember that it is the ‘person’ who is registered for VAT and not the individual business. For this purpose the term ‘person’ includes sole trader, partnership and limited company (a company being treated as a ‘person’). If you run more than one business, even though they are dissimilar, and the taxable turnover of all the businesses together exceeds the prescribed limits then you must register for VAT. All the businesses are covered by one registration; and you cannot register them separately.

How do I register for VAT?

You must complete application form VAT 1. If your business is a partnership you will also have to complete form VAT 2 which shows the names and addresses of each of the partners. These forms and other information are available from your local VAT office (see under VAT or Customs & Excise in the telephone directory).

Once I have registered, what records must I keep?

It will depend partly on the kind of business you run, and is discussed in more detail later in the chapter. But in summary records must enable you to show details of the following:

• the value of output tax on sales
• the value of input tax on purchases
• the amount of total sales excluding VAT
• the amount of total purchases excluding VAT.

How often do I need to advise the Customs & Excise of my transactions?

The details of the transactions are not notified to the Customs & Excise individually as they take place: they would be swamped by a sea of paper! Instead, you accumulate the figures for a three-month period and then advise them as to totals for the period on a VAT return (form VAT 100). An example of the return form is shown in Figure 6.

In order to spread the flow of work over the year, registered traders are split into three groups according to their type of business. These are called stagger groups and each group makes up returns to a different date.

Group 1	Group 2	Group 3
31 March	30 April	31 May
30 June	31 July	31 August
30 September	31 October	30 November
31 December	31 January	28 February

These quarterly periods are referred to as VAT Accounting Periods.

The Customs & Excise will tell you which group you’ll be in.

Exceptionally the Customs & Excise will let a registered person make returns monthly instead of quarterly. This can help if your trade gives rise to frequent VAT repayments. You can also ask for the accounting periods to be adjusted to match the financial year of your business. For more details contact your local VAT office.

How long do I have to complete the VAT return?

You must complete the VAT return and submit it to the VAT office within one month of the end of the VAT quarter. If you are late you will be in default and you will get a surcharge liability notice. This will warn you that if you are late again you may have to pay a penalty surcharge. Each time you default the penalty rate rises to a maximum of f 5% of the VAT that you owe. This penalty threat remains in force until a full year has passed without default. However, if your turnover is less than £150,000 the penalties will not be automatically imposed; instead, advice and support will be offered before such action is taken.

How do I complete the VAT return?

Look at the example in Figure 6. There are a series of boxes where you enter the figures, numbered 1 to 9.

• Box 1 is for the VAT output tax on sales. You must also include VAT on goods taken from the business for your own private use, the motor fuel scale charge (see page 60), and on sales of assets (e.g. machinery or office equipment).

• Box 2 is used to record the VAT due on imports from other EU countries.
• Box 3 is the sum of boxes 1 and 2.
• Box 4 shows the VAT input tax on your purchases.
• Box 5 is the difference between boxes 3 and 4. It represents either the VAT due to the Customs & Excise (if box 3 exceeds box 4) or the sum you reclaim from them (if box 4 exceeds box 3).

The figures in boxes 6 to 9 are used by the VAT office to prepare statistics and to check figures declared in the other boxes on the form.

• Box 6 shows your total sales excluding VAT.
• Box 7 shows your total purchases for the business excluding VAT and certain other expenses such as wages.
• Boxes 8 and 9 are used to record trading with other EU countries.

Full notes for guidance are given on the back of the return. More details on the completion of the return form are given later in the chapter.

What are retail schemes?

You may have heard mention of retail schemes. These are special schemes available for use only in connection with retail supplies.

The retail schemes provide a method of arriving at the value of your taxable retail sales and allow you to determine the proportion of those sales charged at the different rates of VAT. Most VAT registered businesses take these details from the sales invoices that they issue to their customers but for retailers this is not practical due to the large number of sales made direct to the public.

All the retail schemes require you to record the value of your retail sales. In most schemes you work out the VAT output tax on your sales by applying the VAT fraction (see page 47) to the appropriate proportion of your sales.

There are five standard schemes as follows:

• The Point of Sales Scheme: the sales are analysed between the different VAT rates at the time of sale using an electronic till. This is the most accurate but requires an expensive electronic till and staff who know how to operate it.

• The Apportionment Schemes.
  • Scheme 1: sales are apportioned in the ratio of purchases. Thus if 40% of your purchases are zero rated then 40% of your sales are treated as zero rated.
  • Scheme 2: you must work out the expected selling prices of all the goods that you sell and then calculate the proportion of the sales at each VAT rate by applying the appropriate ratio. This scheme can be complex to operate but can be more accurate than scheme 1.

• Direct Calculation Schemes.
  • Scheme 1: under this scheme you work out the expected selling price of your ‘minority goods’ and with this figure known it is possible to establish the standard rated sales chargeable to VAT. Thus if 85% of your sales are standard rated and 15% are zero rated then you must calculate the expected sales revenue from the zero rated (minority) sales. By deducting this figure from the total sales it is possible to establish the value of sales chargeable to the standard rate of VAT.
  • Scheme 2: works in the same manner as Scheme 1 but is available to a wider range of retailers.

There are special adaptations of the schemes for catering and for retail chemists. For more details of these schemes you should contact your local VAT office and ask for leaflet 727.

Can you show me an example of these schemes?

• 1.Where all sales are chargeable at the standard rate the tax content can be found as follows:

• 2.Where sales are partly at standard rate and partly at zero rate then you may be able to use an electronic till with multiple totals to analyse your sales at the time of the sale. If you can establish the value of the standard rated sales in this manner then you can apply the VAT fraction to the appropriate amount in order to calculate the output tax.

Thus:

	£
Total sales at standard rate	35,250
Total sales at zero rate	20,000
	_______
Total sales	55,250
VAT contents of standard rated sales: £35,250× =	5,250

• 3.Where sales are partly at standard rate and partly at zero rate, and you can’t record the division at the point of sale, then you must use one of the retail schemes outlined above to establish the amount of VAT output tax. For example, using the Apportionment Scheme 1, if 75% of the cost of your goods for resale are standard rated, then 75% of your takings are treated as standard rated and the VAT fraction applied accordingly.

What is that odd-looking fraction?

The fraction is used to find the VAT content of an amount that is stated gross (that is, inclusive of VAT).

Using a 17.5% VAT rate, the cost of goods plus VAT will be 100% of the net value (i.e. the cost of the goods) plus 17.5% of the net value for the VAT. The total gross value will therefore be 117.5% of the net cost of the goods excluding VAT.

If you are trying to find the VAT content it will be 17.5/117.5 of the total VAT-inclusive amount of the goods. ((Note: this is not the same as 17.5% of the gross amount.)

By simple arithmetic the fraction 17.5/117.5 can be simplified to 7/47ths, which is an easier fraction to work with (but not much!). We’ll have to assume you’ve got a pocket calculator! This fraction is known as the VAT fraction.

Do I need to provide VAT invoices for all my customers?

Generally, yes; you must give detailed invoices to your customers. The information that you must show is as follows:

• an identifying number (it is usual to number the invoices sequentially so that each has a unique number)
• the date of supply (tax point)
• your VAT registration number as a supplier
• the name and address of the person to whom you are supplying the goods (or services)
• the type of supply
• a description of the goods or services
• the quantity of the goods or the extent of the services you are supplying
• the value of the goods (before any discount) excluding VAT
• the amount of any cash discount
• the rate of VAT (currently 17.5%) and the amount
• the total amount payable.

If the invoice contains details of goods or services, some at standard rate and some at zero rate (or exempt), then your invoice must distinguish between the goods charged at each rate. However, if you are a retailer you only have to give invoices to those customers who ask for a tax invoice. In addition, you can provide modified tax invoices as follows:

• Where the gross value (inclusive of VAT) doesn’t exceed £100 then the invoice need only show the following:
  • the name, address and VAT registration number of the retailer
  • the date of supply (the tax point)
  • a brief description of the goods
  • the total value inclusive of VAT
  • the VAT rate charged.

Note: you can’t include items at different rates of VAT on one modified invoice.

• Where goods exceed £100 then, if the customer agrees, a form of modified invoice can be issued showing the VAT-inclusive value of the standard-rated goods. However, it must also include a summary showing the value of the goods (distinguishing between zero-rated, standard-rated and exempt supplies), the VAT, and the total payable. In all other respects it must be like a tax invoice.

RECORDING VAT TRANSACTIONS

The outline of the VAT system has already been discussed so we’ll now look at the records you must keep if you are registered for VAT.

The normal way of accounting for VAT is on a time-of-supply or tax point basis. This is explained below, but there is an option for a cash accounting basis for VAT purposes for traders whose annual turnover is below £660,000. We’ll come to this later.

The normal basis: tax point system

The time that you have to account for VAT is normally fixed by the time of supply, or the tax point as it is known. VAT must be accounted for in the VAT period in which the goods or services are provided. Of course, this may not be the same as the time when they are paid for if a credit period is involved.

Output tax and sales

There are two aspects to recording VAT on sales:

• the information you need to put on your sales invoice (see page 48)
• the information you need to record in your books of account.

Unless you are using one of the retail schemes (see pages 45 and 51), you will need to keep a separate record of your sales so that the VAT output tax can be calculated. An example of this is shown in Figure 7. Once again, until your business outgrows the system, an exercise book should do to record the transactions: there is no need for any expensive specialised book. Enter the details into it from your copy invoices on a regular basis. Points to note:

• Use a reference number. You should also record it on the copy invoice, and it will help you identify each particular invoice.

• Record the net, VAT, and gross amounts. These amounts should be clearly stated on your invoice. The net amount is the value of the goods before the addition of VAT; the gross value is the value inclusive of VAT.

At the end of the VAT period add the columns up in order to get the figures for your VAT return. Subject to any adjustments (page 59), the total from the ‘Net’ column should be entered as the ‘Value of Outputs’ in box 6 of the VAT return. The total of the VAT column should be entered as ‘VAT Due’ in box 1 of the VAT return form.

Input tax on purchases

Again, unless you are using one of the retail schemes, the VAT book for recording the VAT input tax on purchases is very like that used for sales (see Figure 8). It is, however, useful to add a description of the expense (purchases, telephone, motor expenses, etc.), as this will help when preparing your accounts at the year end.

The total of the ‘Net’ column is used to complete box 7 (Value of Inputs) on the VAT return. The total of the VAT column is then entered in box 4 (VAT Deductible) on the form.

Note: certain items should not be included in boxes 6 or 7, and so should not be written into the VAT books. These are:

• wages and salaries
• PAYE and National Insurance contributions

• money put into or taken out of the business by the proprietor
• insurance claims or compensation payments
• loans, Stock Exchange dealings, grants or gifts of money.

Cash book accounting for inputs

Alternatively, cash book accounting for inputs can be used where you claim the input tax at the same time as you pay your suppliers. In this system you’ll need extra columns in your cash book: as well as the total of each payment, the VAT content and the value exclusive of VAT are also recorded (see Figure 9).

This method does have a drawback: since input tax is not claimed until the time of payment, there can be a delay in claiming it. But since your records are simpler it may be worth accepting this delay.

If you change over to cash book accounting for input VAT make sure you don’t claim the tax on any items of expenditure twice – once under

the old scheme at the time of supply, and again when the payment is made within the new scheme.

Cash book accounting for input VAT is available to any trader (except those using the retail schemes) and does not have the £660,000 turnover limit applicable to the cash accounting basis described below.

Using retail schemes

When using one of the retail schemes, the amount of output VAT on sales you enter on your VAT return is not normally calculated for each individual sale; instead it is calculated from the total sales. The exact details that you will need to record will depend upon which retail scheme you are using.

If all your sales are at the standard rate of VAT (17.5%), then you must keep a record of your daily takings. The VAT content can then be calculated as 7/47ths (17.5/117.5) of the total amount at the end of the VAT period. The actual form of record can be quite simple; a book ruled up like Figure 10 will do. VAT input tax on purchases should then be worked out on the ‘normal method’ outlined above.

If part of your sales are exempt, or zero-rated, for VAT purposes then you’ll have to work out the amount of output tax on sales in proportion to your purchases of goods for resale. The exact calculation will depend on which scheme you are using, but in all of them you’ll have to identify the value of goods purchased for resale which are chargeable at the different rates of VAT.

George Vyner Ltd of Holmfirth, Huddersfield, publish a very good record book for recording VAT for the retail schemes. A sample ruling from the book is shown at Figure 11; it might look complicated at first, but the book includes worked examples to guide you. It is available from most good stationers.

Cash accounting basis

The cash accounting basis is available to traders whose annual turnover is less than £660,000.

What it means

On the tax point system the tax falls due at the time the goods or services are provided. On the cash accounting basis tax is due at the time the cash transaction takes place. The treatment of input tax is therefore similar to cash book accounting described on page 52, but covers output tax as well. This means that when you sell goods and give a period of credit to your customers you won’t have to account for VAT until you are actually paid for the goods. But it also means that where you buy goods on credit you cannot reclaim the VAT until you’ve actually paid for them. This scheme can have cash flow advantages, depending on whether your sales are subject to VAT at a positive rate. If your sales are mainly chargeable at zero rate you’ll have no advantage; it will cause your claim for input tax on purchases to be delayed until payment is made, but without a corresponding delay in the payment of VAT on sales.

Records for cash accounting

The records for cash accounting are essentially the same as for cash book accounting described on page 50, but under the cash accounting basis they also extend to output tax (see Figure 12). Here we have added a column to record the VAT content of each amount received and also a column to record the net amount received (excluding the VAT). At the end of the VAT quarter the total from the VAT column is used to arrive at the figure of output VAT.

Invoices

Details of the information that you must show on your sales invoices are discussed on page 48.

From time to time your accounting records will be checked by the

Customs & Excise VAT office to make sure all VAT has been correctly accounted for. To help their work (and help you get rid of them quicker) it’s recommended that you identify the invoices with your own sequence of numbers, and use the same numbers for reference purposes in your other records. You will also find this reference useful when you want to look up an old invoice. This applies to both purchase and sales invoices.

When the purchase invoices come in, write a number on them corresponding to the next number from the VAT Input Tax Book. When you’ve paid the invoice, file it away in your number order so that if you need to refer to it later you can find it easily.

A similar numbering system should be used for your sales invoices.

Flat Rate VAT Scheme

As an alternative to keeping the conventional records outlined above, with effect from 25 April 2002 it has been possible for small businesses, with a turnover of up to £100,000 (£150,000 from 1 April 2003) to opt for the flat rate scheme. Under this scheme, the business may then dispense with the recording of the input VAT on each individual purchase. This may be an administrative saving for some businesses although they will still need to record the gross value of purchases for income tax purposes.

The trader still charges 17.5% VAT to his customers but he actually accounts for and pays over a lesser figure to the Customs & Excise.

Output tax on sales

The difference in VAT between the two rates is kept by the trader. This is in place of the input tax that would otherwise have been claimed under the regular VAT schemes, and used to reduce the VAT payment to Customs & Excise.

The actual rate of VAT payable to Customs & Excise is dependent upon the nature of the trade. This recognises the fact that certain types of business will incur more input tax than others. Examples of the rates are given in the table below:

Trade	Rate(%)
Retail of food, confectionery, newspapers etc	2
Public houses	5.5
Printing; vehicle repairs	7.5
Manufacture of clothing and textiles	8.5
Hotels and accommodation	9.5
Estate agency, Secretarial services	11
Hairdressers	12
Management consultancy	12.5
Accounting and bookkeeping, legal services, computer and IT consultancy	13

These are only a selection of the rates: for full details you should refer to the Customs & Excise VAT Notice 733 entitled ‘Flat rate scheme for small businesses’.

Although these rates may at first look very attractive you should note that they are applied to the gross turnover when VAT is applied at the standard rate. This is:

Viewed in this way some of the rates look less favourable and you should give careful consideration before you decide to apply for this scheme. Obviously from time to time your business may incur a large expense on which, under the standard VAT scheme, you would have been able to reclaim a substantial amount of input tax. Examples of this might be the purchase of a new delivery van or some expensive production machinery. To allow for such special circumstances under the flat rate scheme, you are permitted to reclaim the VAT on the acquisition of capital assets that cost over £2,000.

One final point to mention is that if you are using the flat rate scheme then when you issue invoices to your customers you should show the full standard rate of VAT (unless the sales are zero rated) and your customers will be able to reclaim all of the VAT (if appropriate) even though you are paying a lesser rate to the VAT Office.

OTHER KEY POINTS ABOUT VAT

If you are registering your business for VAT there are a number of other points you will need to be aware of. These include:

• the treatment of zero-rated sales
• VAT on domestic fuel and power
• items on which you cannot reclaim input tax
• adjustment for private use
• VAT on your motoring expenses
• VAT treatment of certain second-hand goods
• the retention of your VAT records.

What are zero-rated sales?

Most sales by registered suppliers are chargeable to VAT at the standard rate of 17.5%. However, a few categories of goods are charged at zero rate. These are still treated as taxable supplies but no tax is normally charged. The main categories are:

• food
• books (but not stationery)
• some land and buildings (mainly new private dwellings)
• transport of passengers
• certain clothing and footwear (mainly children’s).

Except for the fact that no VAT is charged to the customer, the treatment of these sales should be exactly the same as standard-rate sales.

VAT on domestic fuel and power

An exception to the standard rate of VAT is that the tax charged on supplies of domestic fuel and power is levied at a reduced rate of 5%. This reduced rate also applies to non-business charity use. If you make such supplies you must ensure that your records enable you to account for the VAT on your sales at the correct rate.

Non-deductible input tax

Input tax suffered by a registered person can usually be reclaimed by them (or used to reduce the amount of VAT due by them to the Customs & Excise). However, input tax on certain expenditure can’t be reclaimed. This includes:

• the purchase of motor cars (but VAT on vans or other commercial vehicles can be reclaimed)
• business entertainment
• goods sold to them under one of the second-hand schemes (see below).

Any VAT suffered on these expenses cannot be reclaimed. Accordingly you don’t have to distinguish the VAT in your accounting records; just treat the gross payment (including the VAT) as an expense of your business and analyse it according to the goods or services provided.

Adjustment for private use

VAT input tax may be incurred on goods or services which are partly business expenses and partly the private expenses of the proprietor. In these cases only part of the input tax (the tax on the business part) can be reclaimed. An example might be telephone charges where the business is run from home. For example, if a telephone bill was received for £85.71 plus VAT (£15) and one-third of the expense is considered to be of a private nature, then:

£15× ⅓ = £5 input tax disallowed

The easiest way to account for these adjustments is as follows:

• 1.Reclaim all the input tax in your records.
• 2.When preparing your VAT return make a deduction from the total input tax, disallowing for the private proportion of the tax that you are not entitled to reclaim. Do keep a clear record of how you have worked out the amount so that you can satisfy any enquiry from the Customs & Excise VAT department.

Motoring expenses

There is no need to restrict the input tax on repairs and maintenance of a vehicle which you use partly for private and partly for business purposes; nor do you have to restrict the input tax on road fuel purchased. But where a vehicle is used partly for private purposes and the input tax on road fuel is claimed, you’ll have to apply a scale charge like this:

Quarterly returns 2004/2005	VAT Inclusive Scale	VAT Due
Petrol engines
Engine cylinder capacity:
1400 cc or less	£273	£40.66
Over 1400 cc up to 2000 cc	£346	£51.53
Over 2000 cc	£508	£75.66
Diesel engines
Engine cylinder capacity:
2000 cc or less	£260	£38.72
Over 2000 cc	£331	£49.30

The above table shows the figures for quarterly returns. Those for monthly returns are approximately one-third of these figures. Both monthly and quarterly figures are subject to annual review and you should contact your local VAT office for the latest figures.

These figures represent the tax-inclusive value of fuel deemed to have been used; you’ll have to make the appropriate entries on your VAT return. Supposing you make quarterly returns and use a vehicle with a 1600 cc petrol engine, your entries would be:

Box 1 – Additional output tax = £44.68

Box 6 – Additional outputs

£300 – £44.68 = £255.32

The only way you can avoid the scale charge is by not reclaiming any VAT input tax on fuel that you buy, regardless of whether it’s used for business or private motoring. If you decide not to reclaim you must tell your local VAT office. Depending on how much fuel you buy it can actually work out cheaper to forego the input tax on purchases and not to apply the scale charge.

Note: the scale charge only applies to cars, not to other motor vehicles, e.g.vans. But if you decide to forego the claim to input tax on purchases of fuel you must forego the input tax on all fuel purchased by the business including that used in commercial vehicles.

VAT treatment of certain second-hand goods

In general, VAT is chargeable on the full second-hand values of goods sold by a registered person. However, this can lead to anomalies when dealing with some goods and it is in recognition of this that the secondhand schemes were introduced. The classes of goods covered by the schemes are:

• motor cars
• works of art, antiques, etc.
• caravans and motor cycles
• boats
• aircraft
• electric organs
• firearms
• horses and ponies.

What’s wrong with the normal method of accounting for VAT?

As we have already seen the normal method of accounting for VAT is to charge VAT on the whole of the selling price, deduct the VAT that was charged to you when you bought the goods and account to the Customs & Excise for the difference. This is shown in diagrammatic form in Figure 14.

However, if the person from whom you purchased the goods was not registered for VAT then there would be no input tax to deduct and the amount of VAT payable by you to the Customs & Excise would increase. This could be illustrated as in Figure 15.

This is clearly not the intention of the tax because the amount of the VAT payable would be related to the selling price of the goods and would have no relationship with the value added.

The way round the problem

For goods in the categories listed above special schemes are used to avoid the problem. Although there are minor differences between the schemes they all work in the same way.

Each item must be separately identified in the records and the profit margin on each individual item is calculated (see Figure 16). The profit is taken as being the VAT-inclusive figure of ‘value added’ and the VAT content is found by applying the 7/47ths fraction. For example:

	£
Car – purchased	1265
-sold	1500
	________
Profit margin (including VAT)	235
	_______
VAT content £235× 7/47 =	35
	________

However, where an item is sold at a loss there is no relief given: the loss cannot be set against other profits.

Retention of records

From time to time VAT representatives will call on you to check your records. You must by law keep all your business records (including purchase and copy sales invoices, till rolls if applicable, as well as cash books and ledgers) for at least six years. Where keeping all these records creates a serious storage problem, you can sometimes get permission to keep certain records for a shorter period. However, Customs & Excise approval must be obtained before you destroy any such records.

SUMMARY

• VAT stands for Value Added Tax a tax on consumer spending.
• The VAT system collects tax on the value added to the goods by each registered person handling them (e.g. the wholesaler or retailer).
• You must register for VAT purposes if your turnover exceeds prescribed limits.
• If you have several businesses then they must all be included within one VAT registration.
• Once registered you must account for VAT on a quarterly basis.
• You have a period of one month after the end of the quarter to complete your VAT return.
• Special schemes are available for retailers.
• Your sales invoices must set out certain information if you are registered for VAT.
• Certain items attract VAT at a zero rate.
• Certain input tax is non-deductible.
• Where expenses are incurred for both business and private purposes then the VAT input tax must be apportioned accordingly and part disallowed.
• Special rules apply for fuel provided for private motoring.
• If your turnover is less than £660,000 then you have the option of using the cash accounting basis.
• The flat rate VAT scheme is available for small businesses.
• You must keep your VAT records for at least 6 years.