If it is true that the only two things in life you can depend on are death and taxes, there is one more we can add for small business owners in the UK: VAT. UK consumers pay VAT on just about everything they purchase. As such, VAT is a normal part of doing business here.
The good news is that VAT doesn’t have to be all consuming. There are ways to address it and still maintain your business sanity. There are certain strategies you can pursue as you maintain compliance and keep your cash flow positive at the same time. Actually, it really boils down to the three key strategies explained below.
1. Choose Standard or Flat Rate
The first strategy is to figure out whether standard VAT or flat rate is better for your business. Let’s start by establishing the fact that there is a certain threshold that establishes whether or not a business is required to register for VAT. That threshold currently sits at £85,000.
Next, companies register for VAT under one of two scenarios. The first is a scenario in which the company acknowledges its revenue generated from non-exempt goods and services over the last 12 months has eclipsed the threshold. The second scenario dictates that, although sales have not yet reached the threshold, they probably will within the next 30 days.
That leads us to the question of which scheme to register for. The key difference between the two is how a company deals with its own VAT purchases:
- Standard VAT – Under the standard scheme, businesses charge their customers VAT on all non-exempt purchases according to established rates. Then turn around and pay that money to HMRC. They can also reclaim some of the VAT they have paid as a result of operating their businesses.
- Flat Rate – Under the flat rate scheme, companies pay a fixed rate of VAT determined by the type of business they are involved in. They cannot reclaim VAT on their own purchases except under special circumstances governing capital assets worth more than £2,000.
The primary advantage of flat rate VAT is that the business pays less to HMRC with every tax return. Furthermore, the business gets to keep the difference between what it collects and what it pays. This makes flat rate a better deal for small businesses that do not expect to pay a lot of VAT themselves.
2. Separate VAT Money from General Receipts
This second strategy is one that far too many businesses fail to practice. It is a strategy that dictates all VAT monies be separated from general receipts. In other words, the extra money charged to cover VAT should not be considered revenue. Look at it as tax money you have been given temporary stewardship over. Put it away in a separate account so that it is there when the tax bill comes due.
The highest VAT rate in the UK is 20%. That means for every £1.00 in purchases of qualifying goods or services, the merchant actually collects £1.20. The smart business owner puts £1 in with general receipts and the other £0.20 in a separate account. This strategy guarantees that the money to pay VAT taxes is always available when needed.
If something does go wrong and the money is not there for whatever reason, the business owner should at least think about taking out a Loan To Pay Tax Bill obligations. A VAT loan can be had as a short-term loan with very reasonable rates. Loan charges are offset by the savings in tax penalties.
3. Don’t Wait to Register
Finally, business owners should not wait to register for VAT if they have any expectation of actually having to pay it anyway. You may run a company with annual qualifying revenues of just £60,000. You have not registered for VAT as of yet because you are not required to by law. That’s fine. But because you are not registered, you also cannot reclaim any of your own VAT costs.
Being able to reclaim VAT reduces a company’s overall operating expenses. As such, it increases cash flow, which is critical for small businesses trying to grow. This suggests that if growth is part of your long-term strategy, you will eventually be paying VAT one way or another.
Registering now will allow you to reclaim some of the VAT you pay in pursuit of that growth. Assuming you are investing quite a bit in your company’s future, you might also be paying quite a bit of VAT. Doesn’t it make sense to register now and get some of that money back?
Of course, registering for VAT means your prices will automatically go up. And yes, that may cost you some business. It is not likely to harm your company in the long run, though. UK consumers are so used to paying VAT that it will probably not faze them.
VAT is a fact of life for UK business owners. Hopefully the three strategies you read about here will help you address VAT in such a way that you control it rather than it controlling you. That is the way it should be.