What is the VAT system? A handbook for new business owners
Most individuals understand the basic concept of VAT; after all, as consumers, we are well aware that VAT raises the cost of the majority of our purchases. If you own a business, however, you must understand much more, as appropriately processing VAT within your company is one of the most important ways to verify that your company is operating legally.
If you are starting a new business for the first time, you will need to familiarise yourself with VAT. Here's a primer to help you understand what VAT is, how it works, and what your responsibilities as a business owner are.
What exactly is VAT?
VAT, or value-added tax, is a consumption tax that is applied to the price of products and services. It was first introduced in the United Kingdom in 1973. In general, the following areas may be liable to VAT:
- In the process of exchanging one thing for another.
- The costs of hiring or borrowing items
- Asset sales in business
- Commissions
However, VAT does not apply to every product or service sales because some are either outside the area of VAT or exempt from VAT. Health care, education, insurance, and postage stamps, for example, are exempt from VAT, while charitable donations are not. Furthermore, any statutory fees, commodities, or services acquired and utilised outside of the UK are exempt from VAT.
Who is responsible for VAT?
VAT is a tax that is paid by customers. While businesses are responsible for paying VAT to HMRC (Her Majesty's Revenue and Customs), the expense has already been borne by the business's paying customers. Essentially, businesses are required to charge and collect VAT on behalf of HMRC and to fully report it.
What is the current VAT rate?
In the United Kingdom, three VAT rates are applicable based on the goods or services delivered.
Currently, the VAT rates in the United Kingdom are:
- Rate
- Percentage
- Examples that are applicable
- Standard
- a percentage of 20%
- The majority of products and services
- Reduced
- 5% of the total
- Select products and services, such as utility bills
- Zero
- zero percent
- Most foods and clothing for children
What is the VAT exemption threshold?
The VAT threshold is the amount of money that your business can make before having to register for VAT.
In the United Kingdom, the current VAT threshold is £85,000. When you reach a turnover of £85,000 or more, you must register your firm for VAT.
Once registered for VAT, you must charge VAT on all goods and services sold by your company. By registering for VAT, you are also legally permitted to reclaim any VAT expenditures incurred by your firm on any goods or services purchased.
It's vital to understand that until you're registered, you can't lawfully charge (or claim) VAT. While you are not legally required to register for VAT if your business turnover is less than the threshold, you can do so if you like. So-called "voluntary" registration is what we're talking about here.
When assessing whether your company has crossed the VAT threshold, keep in mind that it is calculated over a rolling 12-month period rather than a tax year or calendar year. In other words, if your company has a turnover of £85,000 in any successive 12-month period, it is time to register.
How to Apply for VAT
You can usually register for VAT online. You create a VAT online account (also known as a 'Government Gateway Account') when you register online.
Once registered, you should obtain your VAT registration certificate within two to four weeks of submitting your application. This certificate will contain your company's VAT number.
If you want, you can have your accountant or tax agent register your company for VAT on your behalf.
It is also crucial to know that you must register for VAT if your business turnover is expected to reach the threshold over the following 30 days or if you take over a VAT-registered going concern.