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What does VAT mean and its impact on small businesses

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What is Value added tax (VAT)? This is the tax charged by many suppliers of goods and services by adding it to those goods and services. Business supplies entail the following; hiring of goods, selling of goods, renting, and business stock used for private reasons. The services include: a price which is charged for admissions into the buildings, giving supplies as a self-employed person and hairdressing.

Types of VAT and their differentiation

VAT rates change in accordance to the goods and services being supplied. The VAT rate has four categories;

  1. Zero rate: this rate is charged on most of the foods apart from takeaway meals & restaurants, shoes & clothing for children, new house sales & prescriptions, books & newspapers. If all the goods you supply are zero-rated, it’s not a must for you to register for VAT but it’s mandatory to apply for exemption from registration.
  2. Exempt supplies: this comprises services such as finance, education, insurance, dentists & doctors but not osteopaths and some other services. VAT is not charged on exempted supplies. You cannot register for VAT if what you supply always is exempt services. On the other hand, if you have some exempt supplies and you’re VAT registered, you may have a hard time to reclaim all your input tax.
  3. Standard rate: it is implemented to all the goods and services that do not lie under the other three categories (zero rate, exempt supplies & reduced rate). Currently, the rate is at 20% as from 15% which had been lowered in 2008 due to recession to aid the falling consumer confidence at that time. Later in January 2010, the rate was returned to its original percentage of 17.5% and around January 4th 2011, it was raised to a rate of 20% as a way to reduce the UK’s budget deficit.
  4. Reduced rate: this comprises of 5% of power and fuel applied in homes and charities.

A person has to register for VAT once their turnover gets to the threshold or can do so in a span of 30 days. In order to figure out whether to register for VAT or not, dismiss the value of all capital assets from buildings, vehicles or even equipments that you have sold and all exempt supplies. Postponing registration can turn out to be expensive as you will be required to pay the HMRC the tax that you should have collected in addition with a fine. Serious penalties are charged for late registration and VAT nonpayment. Almost every business collects more tax from their customers as compared to that of which they pay to their suppliers. A quarterly VAT return is filled in and the excess is paid to the HMRC. Those that need to register are supposed to account for VAT every time they supply goods and services.

Concerning VAT, the tax a person charges on supplies is their output tax. While for customers that are registered for VAT and are using your supplies for their business, you are required to register the tax you charge them as their input tax. What is Input tax? This is the VAT that you pay to your suppliers for business purchases and expenses. Input tax is made up of; VAT on raw materials, things bought for re-sell, business equipment, business phone calls and professional service payments. If on more occasions you collect lesser VAT than what you pay, you’re allowed to fill in a return every month and claim to be refunded by the HMRC. But also, a person is not allowed to reclaim input tax on certain entertainment expenses, some cars and if your supply is only on exempt goods and services.

While undertaking VAT, put in mind that it is you and not your business that is registered for VAT. When you register, all parts of your business are covered and therefore, you are only required to register once. If you purchased your business from someone else, you need to check at the taxable turnover and find out whether you need to register. The day you take over, the business becomes your registration date. You can also retain the current VAT number if only the initial owner of the business was VAT registered. Since April 1 2010, a business or person with an annual VAT exclusive turnover of around £100,000 or more must present their VAT returns online and make payments of their bills electronically. It is also used if you register for VAT as from April 1 2010 and beyond without considering your turnover. For those using HMRC online services for the first time, they are required to register for an online account. For a person to register for VAT they need to contact their local HMRC office or they can also complete the relevant forms online at www.hmrc.gov.uk/vat .

At What stage can you deregister from VAT?

A person can deregister from VAT or cancel their VAT registration when their business turnover falls below a certain limit. At the moment, the deregistration limit is at £79,000.

Discussed below is the cash accounting scheme for VAT

The rules of VAT are changing every year, in order to enable the complex business of registering and filling in VAT returns much simpler. Special schemes have been put in place to make life easier for small and medium sized enterprises. The Cash Accounting Scheme for VAT allows you to account for VAT on the basis of payments made and received by you, in place of on the basis of invoices issued. This implies that you automatically have bad debt relief and it also assists if you give room for periods of credit or have late payers. The cash accounting system limit is used by business with a turnover of £1.35m. The scheme can be used until the turnover reaches £1.6m. Annual accounting takes out the slog of quarterly tax returns that small business people have. After registering for VAT for over a period of 1 year, you are allowed to send in just one annual return and make monthly payments by direct debit.

What VAT records should you keep?

Instead of keeping records for the HMRC, a person is required to be punctual in VAT record keeping. You have to record every business transaction that you conduct, and keep documents such as bills, bank statements, receipts and cheque stubs for support. Another requirement is for you to split up your business transactions from your personal finances. For the purposes of VAT, it’s mandatory to keep a record of every supply you create, receive and a summary of VAT for every tax period taken care of by your tax returns. The records should be current and simple to find and if you register for VAT you have to keep your records for six years. Most of the businesses select to employ an accountant or at least a book keeper at this level in order to reduce stress out of the paperwork and leave them time to continue with managing their business, especially that there are grievous penalties for failing to keep records. For instance, a builder asks to be paid in cash and you may naturally assume that the builder is being less open with the taxman. But he may also have another more pressing issue on his mind, the desire to evade getting involved in VAT, the setback of most of the small businessperson’s existence. Head of business law at the association of certified and chartered accountants, John Davies, confirmed: “When small businesses complain about burdens on business and regulation, VAT always comes out either at or near the top.” He added; “[But] the government is now trying to make it easier for small and medium enterprises to deal with VAT”. VAT limit registration is continually being increased. At the moment, you must register for VAT if your annual taxable turnover is more than £81,000 in the past 12 months, or if the value of taxable supplies has a probability of surpassing that sum in the next 30 days.

Despite that sounding like more cash, businesses that are seasonal and obtain a lot of profit during Christmas, for instance, it becomes easy to breach the limit within a short period. VAT registration reflects turnover and not profit; therefore, a small builder that makes comparatively little profit but deals with expensive materials is needed to register. While for people that grumble about being an unpaid tax collector for the government, compensations are available. If you’re registered for VAT, it’s possible to save some money and some select voluntary VAT registration before they hit the limit. The changes that were made to the law imply that VAT returns are becoming easier.