A change being made to the VAT Flat Rate Scheme on 1 April 2017 will force many businesses to leave the scheme.
In the article entitled When Must Your Business Start Charging VAT? we considered when a business would need to become registered for Value Added Tax (“VAT“) and begin charging its customers VAT.
This article provides an overview of certain key obligations a newly VAT registered business needs to be aware of issues regarding how VAT is charged, including:
- the rate at which VAT should be charged,
- when it should be charged,
- when and how it must be shown on sales invoices or receipts, and
- how it should be declared and subsequently paid across to HMRC.
How Much VAT should I Charge?
There are actually three categories of taxable supply, with VAT being charged on each one at a different rate:
- Standard Rated – 20%
- Reduced Rated – 5%
- Zero Rated – 0%
The VAT is charged by multiplying the value of the supply by the VAT percentage rate applicable to its category. This is then added together to give the final cost to the customer.
HM Revenue and Customs (“HMRC“) does not maintain a listing of the specific VAT rate applicable to every potential type of taxable supply. Instead, they outline the products or services that are either zero-rated or reduced-rated supplies; any other taxable supplies are therefore considered to be standard rated unless they are exempt.
You should firstly consider therefore whether your supplies should be classified as zero-rated. These are detailed in Schedule 8 of the VAT Act 1994 and include the following types of supplies;
- food and some drinks unless supplied in a café or restaurant or to be taken away hot,
- books, newspapers and some other printed matter,
- protective boots and helmets,
- most children’s clothing,
- construction of new residential buildings,
- some caravans and houseboats,
- some products for use by the disabled,
- domestic supplies of water and sewage services, and
- the transport of passengers in certain circumstances.
If your supplies do not qualify for zero rating, you should next consider whether they should be reduced-rated. These are detailed in Schedule 7A of the VAT Act 1994 and include the following types of supplies;
- supplies of domestic fuel or power,
- children’s car seats,
- sanitary and contraceptive products,
- smoking cessation products,
- some conversions into new residential dwellings,
- some caravans,
- mobility aids for the elderly, and
- installation of energy saving materials.
If your supplies are neither zero-rated or reduced-rated they should be considered as standard rated.
Determining which of the above categories your sales fall into can be done by looking at the detailed guidance available on the HMRC website. In some cases application of the detailed provisions contained within Schedules 7A and 8 of the VAT Act 1994 can be quite complicated, in which case it may be advisable to obtain professional advice.
How Do I Charge the VAT?
HMRC have very clear requirements regarding the manner in which a customer should be charged VAT, in particularly the requirements regarding VAT Invoices.
Most businesses issue sales invoices or sales receipts to their customers, but where the customer is itself a VAT registered business, a VAT invoice must be issued.
Your existing sales invoice or receipt can also serve as a VAT invoice provided it is amended to include certain additional information such as your VAT registration number, details of the goods and services supplied and an analysis of the VAT charged.
Further details about exactly what should be put on a VAT invoice are available on the HMRC website here.
You do not have to issue VAT invoices to individuals or businesses who are not registered for VAT. If your business is retail based whose customers are primarily members of the public, you can assume that your customers are not registered for VAT themselves and, therefore, whatever you issue as an invoice or receipt does not need to include all the details that a VAT invoice would require.
But you are still obliged to supply a VAT Invoice when requested to do so by any of your customers.
If you are not dealing with the public directly, make your standard sales invoice or receipt compliant with the VAT Invoice requirements and use these to invoice all your customers, irrespective of whether they are registered for VAT or not.
Finally, it is acceptable to issue VAT invoices in an electronic format provided they comply with the general VAT invoice requirements, but a customer can still insist on receiving a paper version.
When Do I Charge the VAT?
This is an issue that needs a little more consideration than you would think. There are detailed rules concerning when a taxable supply of goods and services is deemed to have taken place for VAT purposes. This is known as the tax point.
Tax points are important because they determine which VAT return period a particular sale must be included in. Tax returns are considered further below.
The basic tax point of a transaction is taken to be the date of supply of the goods or services, being;
- For goods – the date on which they are dispatched or removed to the customer.
- For services – the date on which the service is completed.
HMRC realise that many businesses will not issue invoices on the same day as an actual supply of goods or services is made and, accordingly, the basic tax point above can be overridden with the actual date on which the related VAT Invoice is issued, provided it is issued within 14 days of the date of supply.
Businesses that only issue their invoices once a month can ask permission from HMRC for this to be extended to 30 days.
An important override of the above rules occurs where cash is received in advance of the tax point, for instance when a deposit is taken. In this case, the date of receipt of the cash becomes the tax point for that cash receipt; when the related goods or services are finally supplied, this will create a second tax point for the remaining balance due.
It is important to appreciate that getting the tax point of a sale wrong can result in penalties being charged by HMRC.
Finally, do not put VAT on your invoices until you have received your VAT registration number from HMRC. More information on this point can be found in the article When Must Your Business Start Charging VAT?
Reporting VAT to HMRC
As a VAT registered business you will also need to prepare regular VAT Returns and submit them online to HMRC. The VAT return is a one-page document disclosing, for a prescribed accounting period, the sales and purchases made in that period and the related VAT charged or incurred.
The prescribed accounting period for a return is normally 3 months in length ending on regular quarter end dates. Upon registration, HMRC will inform you which specific quarter ends they require you to send returns for; you may request that these quarters be changed, for instance to fit in with your year-end date. A business can also request to make returns on a monthly basis instead.
A scheme also exists to enable some businesses to submit an annual return only, although payments of VAT are still required throughout the year, this time on an estimated basis.
VAT returns must be submitted electronically within one calendar month plus 7 days from the end of the return period unless you are on the annual scheme, in which case you do not have the additional 7 days. Payment of any VAT liability due for that return must be made to HMRC by the same date.
A penalty regime is in place for when VAT returns and their related payments are submitted late.
So far we have discussed VAT on sales. This is known as Output Tax.
A VAT registered business making taxable supplies to its customers on which it is charging VAT may reclaim any VAT it has itself suffered on its own purchases; this is known as Input Tax.
The reclaim for input tax is made on the VAT return by deducting it from the amount of output tax due to HMRC for that period. If the value of input tax exceeds the output tax, HMRC will issue a refund to the business.
To be able to make a claim for input tax a business must ensure it has evidence to back up this claim. In nearly all cases, the best evidence is a VAT invoice from your supplier; they must furnish you with one if you make such a request.
Ensure you make the effort to obtain adequate evidence of any input tax you have paid, or HMRC may deny you a refund of the amounts incurred.
Penalties – Failure to Submit Returns or Pay HMRC.
If you miss the deadline to file your VAT return or make payments of your VAT liability you will enter what’s called a 12-month Surcharge Liability Period. Where any subsequent deadlines are missed during this period surcharges become payable, with the potential fine increasing each time.
In addition, missing a deadline within the 12-month surcharge liability period restarts the surcharge period anew for another 12 months starting from the new missed deadline. You would therefore need to meet the deadline to submit your quarterly returns, and pay any related VAT liability, 4 times in a row to get out of this surcharge cycle.
Penalties – Mistakes.
Errors on Vat returns can also lead to penalties that range in scale. If you are aware that you have made a careless but not deliberate error, you can correct it in your next return if it is below £10,000 in total or below both £50,000 and 1% of turnover for the period. It is also worth making a disclosure of this error to HMRC via form VAT652.
If your error involves the accidental overcharging of VAT to your customers, HMRC are unlikely to refund you for this error if you do not intend, or unable, to pass the refund on to the customers who were overcharged.
As always, this article is intended to give a general overview of certain VAT issues. It cannot be, and is not intended to be, a substitute for the specific advice that you should obtain when addressing your own situations. This specific advice can include reviewing HMRC guidance yourself or seeking professional advice.