A change being made to the VAT Flat Rate Scheme on 1 April 2017 will force many businesses to leave the scheme.
This article is aimed at UK businesses that do not currently charge Value Added Tax (“VAT“) on the sale of their goods or services. It will be assumed that the customers of the business are UK based, although a couple of related issues regarding sales to EU customers are considered towards the end of the article.
There are two initial points that a business must consider when determining whether they need to start charging VAT on their sales.
Firstly, could VAT be chargeable on the particular goods or services that the business supplies to its customers and secondly, if it could, when does the business need to start charging its customers this VAT?
Does VAT Apply to My Types of Sales?
VAT is chargeable on the supply (i.e. sale) of most, but not all, goods and services. Those on which VAT is potentially chargeable are known as taxable supplies, whilst those on which VAT is not chargeable are referred to as exempt supplies.
Only a business that makes taxable supplies will need to consider charging VAT; if all the goods and services that your business sells are exempt supplies, there is no need to consider UK VAT requirements any further.
HM Revenue and Customs (“HMRC“) does not maintain a listing of the VAT status of every type of product or service that could potentially be sold by a business. Instead, they outline the products or services that are exempt supplies; these are detailed in Schedule 9 of the VAT Act 1994 and include the following types of supplies;
- most supplies of land,
- postal services,
- betting, gaming and lotteries,
- financial services,
- burial and cremation,
- professional subscriptions,
- sports competitions,
- charity fund raising events, and
- cultural services.
If the goods or services you sell are not included in Schedule 9 of the VAT Act 1994, you can assume that they are taxable supplies.
As a first step, therefore, you should consult the HMRC website to determine if some (or all) of your goods and services are to be treated as exempt supplies. For those that are not on the list, you should consider them to be taxable supplies on which you might need to charge VAT.
When Must I Start Charging VAT?
A sole trader, partnership or company must begin charging VAT from the date it is required to be registered for VAT with HMRC.
It is required to register for VAT when the amount of taxable supplies it makes exceeds the annual registration threshold.
From 1 April 2017, the annual registration threshold is £85,000.
In simple terms, we look at the level of turnover or revenue generated from the sale of taxable supplies and compare it to the registration threshold above.
This comparison is actually undertaken in two ways.
Historic Turnover Test
First, the “historic” turnover test looks at the level of sales that a business has made in the past year; this test should be performed at the end of every calendar month.
For this test, total up the value of all taxable supplies made by the business in the 12 months to the end of the calendar month under review. If the value of the taxable supplies in that 12-month period exceeds the annual registration threshold above, the business must register for VAT with HMRC.
You must notify HMRC of your need to register within 30 days of the month end. HMRC will send you a VAT Registration Number and you will need to start charging VAT on your sales from the 1st of the next month.
We would advise all businesses to maintain a rolling 12-month total of their turnover which they update at the end of every month.
A trader who has breached this threshold may not have to be registered if they write to HMRC, providing evidence that the turnover of their business in the next 12 months is not expected to exceed the current deregistration threshold (£83,000 – 2017).
HMRC may agree not to proceed with registration, but note that the trader must still contact HMRC in this situation; it is not enough to simply ignore the registration requirements completely.
Future Turnover Test
Unless you are now required to register under the historic test above, you must also consider the “future” turnover test.
This test requires a business to register for VAT if at any time it expects the value of its taxable supplies in the next 30 days to exceed the annual registration threshold.
Again, HMRC must be notified within 30 days of this date, but in this case you will need to begin charging VAT on your sales immediately.
This test is designed to catch situations where large orders will take a business over the annual registration threshold in “one hit”; HMRC would not like these large orders to escape the possible imposition of VAT.
Breaching this test adds the extra complication of being required to charge VAT immediately even though you may not yet have received your VAT Registration Number from HMRC. This is considered further later in this article.
If You Need to Register for VAT
If you have breached one or other of the turnover tests above, you generally have 30 days to register for VAT, which is done online via the HMRC website.
Once you have registered, HMRC will send you your unique VAT Registration Number; you cannot charge VAT on your invoices until you have received this number.
Once you have received your VAT registration number you should begin charging VAT on the taxable supplies you make on or after your registration date.
The VAT you charge is known as Output Tax. There are additional requirements to consider regarding how you charge this output tax on your sales, including;
- the rate at which the VAT should be charged at,
- the specific date on which it should be charged,
- how it must be shown on sales invoices or receipts, and
- how it is declared to HMRC.
Further details about these requirements can be found in the article Charging VAT for The First Time.
Once registered you may be able to reclaim any VAT your business has itself incurred on costs and expenses. This VAT is known as Input Tax. You will need to ensure you retain adequate evidence to support any reclaim of input tax that you make.
Charging VAT Before You Have A VAT Number
You are not allowed to include VAT on an invoice you issue until you have received your VAT registration number. This causes a problem where you fail the “future” turnover test, since you will be required to charge VAT to your customer(s) immediately but it is unlikely you will receive your VAT registration number in time from HMRC.
In this case, do not add anything described as “VAT” to an invoice you issue before you have your registration number. You should instead explain to your customer that you are unable to issue them with what’s called a VAT invoice at present, since you do not have a registration number. You can issue them instead with a pro forma invoice, adding an amount to the agreed sales price to cover the VAT that will eventually be charged.
Once you do receive your VAT registration number, issue your customer with a VAT invoice to replace the pro forma one.
Where you issue a pro forma invoice it is advisable to also include on it a statement such as “This is not a VAT invoice”
More details about VAT Invoices can be found in the article Charging VAT for The First Time.
Failure to Register for VAT When You Should
Failure to register for VAT when required can lead to a failure to notify penalty becoming payable. The penalty charged is calculated as a percentage of the undeclared VAT liability. It can be reduced if prompt disclosures are made to HMRC, or where the taxpayer has a reasonable excuse; but note that HMRC do not offer a very wide interpretation of what constitutes “a reasonable excuse”.
Equally as important is the fact that HMRC will also backdate your VAT registration to the date at which the business should have been registered from. VAT will then need to paid over to HMRC on all taxable supplies made since that date, even though you would not have actually charged your customers this VAT. You could therefore be handing over to HMRC up to 1/6 of your turnover from this date.
Failing to register on time for VAT can be a very expensive mistake. This is why we advise you to keep an up to date running total of your 12-month turnover.
It is possible to voluntarily register for VAT if you have not yet breached the annual registration threshold. The primary advantage of doing so is that you may be able to reclaim from HMRC the input tax suffered on your business expenses, a cost that your business otherwise has to absorb itself.
However, as well as the compliance burden, an obvious disadvantage of VAT registration is the impact it can have on your competitiveness, since you will have to add an additional amount of up to 20% to your prices. Where your customers are members of the public, or businesses that are not themselves registered for VAT, this will make your prices less competitive and may therefore impact on your business.
If instead your customers are themselves VAT registered, the pricing issue should be less of a problem since these customers are likely to be able to reclaim back from HMRC the VAT you charge them, and they will therefore be less concerned about a price increase resulting from your VAT registration.
One situation where voluntary registration should nearly always be considered is where the taxable supplies you make are zero-rated, meaning that you charge a 0% rate of output tax but can still reclaim all your input tax.
Registering Multiple Businesses
Technically it is the “person” not the business that is registered for VAT. A person can be a sole trader, a partnership, a company or any other legal entity. It is therefore the combined turnover from all of a “person’s” businesses that would need to considered when comparing historic or future turnover against the annual registration thresholds.
A sole trader, as an example, could have multiple businesses which are each individually operating below the registration threshold but their turnover, when combined, breaches the threshold. In this case, the trader would need to register for VAT, and each business will need to charge VAT on its taxable supplies.
HMRC have strict rules in place to prevent situations where a business has been artificially separated to avoid registration for VAT. In particularly, they look for situations where;
- two (or more) apparently separate businesses are, in reality, operated by a single entity, or
- multiple legal entities are carrying out a single business.
If you are caught artificially separating your businesses, HMRC can ignore the separation and insist that VAT registration should have occurred for the entities or businesses as a whole; penalties and backdated VAT liabilities can therefore follow.
It is important to stress though that having similar businesses operating across multiple legal entities is still perfectly acceptable provided there is a valid commercial reason for doing so and the entities are actually operated separately in practice.
Selling to EU Customers
Although this article does not address the particular VAT issues that arise when selling goods and services to EU based customers, two related registration issues are briefly worth mentioning. These concern distance selling and digital services.
Distance selling involves the regular sale of goods (but not services) by a UK business to certain customers who are resident in another EU country. A typical example would be selling goods over the internet.
Where the EU based customer is not registered for VAT themselves, such as a member of the public, the UK seller will charge UK VAT in the normal way until the total value of these relevant sales into any particular EU country over a calendar year exceeds the distance selling threshold.
A distance selling threshold is set for each individual EU country at either EUR 35,000 or EUR 100,000; each EU country may choose which one to apply. As examples, Germany and Holland have opted for the higher threshold, while France, Spain and Italy have opted for the lower one.
Where the annual value of sales of relevant goods into an EU country exceed that country’s distance selling threshold, the seller must stop charging UK VAT on these sales, register for VAT in the specific EU country and begin charging VAT at the local rates to these types of customers. They will also need to comply with all local VAT reporting requirements.
A business will therefore need to register for VAT in every EU country in which annual sales of goods to non-VAT registered customers exceeds the distance selling threshold for that country.
Digital Services comprise the sale of certain telecommunication, broadcasting and e-services to non-registered customers in other EU countries. Examples of such services are video on demand or the sale of downloadable items such as games, music and apps.
Where a UK business makes any sales of these types to non-business customers in the EU, they must not charge UK VAT on these sales. Instead, they need to charge VAT at the local rates applicable to the EU country in which their customer resides.
The business must either register for VAT in each EU country where it supplies digital services, or make use of the centralised VAT Mini One Stop Shop (VAT MOSS) system and submit a single VAT Moss return for each quarter covering all relevant sales of digital services in all EU countries.
The use of VAT MOSS enables a business to avoid the onerous task of registering for VAT in multiple EU countries. Further details about VAT MOSS are available on the HMRC website here.
Unlike distance selling, there is no threshold; any amount of relevant sales of digital services will need to comply with these rules.
Note that simply communicating with a customer by email, including sending them electronic versions of business documents does not constitute digital services.
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.