What is VAT and how does it work?

If your business is registered for VAT you'll pay VAT on your purchases (‘input tax’) and charge VAT on your sales (‘output tax’).

The standard rate of VAT is 20% although there is a low rate and a nil rate too.  If you supply goods or services that are zero rated you'll still need to register for VAT and then apply for an exemption.  More information on the different VAT rates that apply to different goods and services is available from the HMRC website.

If you're registered for VAT the cost to your business is ultimately neutral because if your business receives more output tax from sales than it pays in input tax on purchases you simply pay the difference to HMRC. If more input tax has been paid than output tax charged HMRC will refund you the difference.  What it does mean is that you can re-claim some or all of the VAT you pay on goods or services you use for your business.

Who needs to register for VAT

You don't have to be a Limited Company to register for VAT, and if you are a Limited Company you don't necessarily need to be VAT registered.

You must register for VAT once your turnover (not profit) is above the VAT threshold.  The VAT threshold is £79,000 in any 12 month period (in the 2013/2014 tax year) and you must, by law, register for VAT within 30 days of reaching this level of turnover.

Information on registering for VAT is available from the HMRC website or call the VAT helpline on 0845 010 9000. 

What happens when your business is VAT registered

When you're registered for VAT you need to:

• Charge the correct rate and amount of VAT on ALL of your sales
• Show the rate and amount of VAT charged on your invoices
• Include your VAT registration number on your invoices
• Submit a quarterly VAT return to HMRC, and pay or reclaim any VAT due
• Keep copies of all VAT invoices you send for a minimum of six years

Voluntary VAT registration

Even if your business turnover is below the VAT registration threshold you can register voluntarily for VAT.

Advantages of voluntary VAT registration

• You'll be able to reclaim some of the VAT you pay on your business purchases
• It adds credibility to your business
• If your customers are VAT registered they can reclaim the VAT you charge them

Disadvantages of voluntary VAT registration

• The extra admin of keeping a record of input and output tax, and completing regular VAT returns
• If your customers are not VAT registered your prices will seem high as they can't reclaim the VAT