A Guide To Direct And Indirect Taxation In The UK – How To Save Money (Chapter Seven)
Story Highlights:
VAT is the topic of this chapter and you’ll find information about:
- The introduction of VAT
- Present-day VAT rates and who pays VAT
- Registering for VAT in the UK
- Completing VAT returns
- Making VAT payments and deadlines
- Late VAT returns and the surcharge period
- Financial penalties for VAT
- Whether you should voluntarily register for VAT
- Alternative VAT schemes
- VAT and consumers
- The size of VAT avoidance, fraud and evasion
History of VAT in the UK
VAT (Value Added Tax) is so much a part of our everyday lives nowadays that it’s easy to forget that it’s actually one of our newest taxes.
We’ll look briefly at the history of VAT in the UK before giving practical guidelines about registering for VAT, how to complete VAT returns as well as how to pay and any financial penalties for late submissions or payments.
Did you know that it’s possible to voluntarily register for VAT? We consider under which circumstances it might be good business sense to register even if you earn under the VAT threshold.
We explain different schemes to simplify the way you calculate and pay your VAT before looking at VAT from the point of view of a consumer and then through the eyes of a taxpayer when we see the size of the problem of VAT avoidance, fraud and evasion.
1940-1973 – The Purchase Tax
The precursor of VAT in the UK was the Purchase Tax, which existed between 1940-1973. Its name was slightly misleading since it was added during the manufacturing and distribution process rather than at retail outlets.
This tax was created to help finance military expenditure during the 2nd World War and at one point reached a staggering 100%.
1973 – The introduction of VAT
The Purchase Tax was replaced by VAT in April 1973 when Britain joined the European Union. At the beginning it was a standard 10% rate on most goods and services.
In the decades since then, what has changed is the rates at which it is charged and for which products and its complexity.
In 1974 the standard rate was reduced to 8% while some luxury goods were increased to 12.5%. In 1979 the standard rate was almost doubled to 15% and the higher rate was abolished – partly to pay for the reductions in income tax in that period.
In 1991 the rate of VAT was raised to 17.5% in order to increase revenue in light of the reductions in the community charge (or poll tax).
In the years 1997-2007 its organisation was once again changed so that some products were only charged 5% for VAT. In 2011, VAT went up to 20%, reflecting the state’s tendency to raise indirect rather than direct taxation.
Present-day VAT rates and who pays VAT?
Apart from changes in the percentage rates for VAT, the handbook for VAT legislation runs to thousands of pages to take account of which goods and services are eligible for VAT.
There are now 3 different rates for VAT: the standard rate (20%), the reduced rate (5%) and the zero rate (0%).
Essential products such as foodstuffs are charged at zero, some products (such as children’s car seats and products to give up smoking) are calculated at the reduced rate while other goods are charged at the standard rate. Some services are exempt from paying any VAT at all.
For example, financial services like insurance, health services, educational services (schools and lessons) and postage stamps.
Visit the government website for a more detailed analysis of which goods and services are calculated at the different VAT rates.
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This VAT-threshold is one of the highest in the world. Businesses with a lower turnover but which wish to reclaim the VAT they pay on products they use in their business or production are also able to voluntarily register for VAT.
Summary:
The Purchase Tax of 1940-1973 was replaced by VAT when Britain became a member of the European Union.
The standard VAT rate of 10% in 1973 has gradually risen to 20% showing the state’s preference to increase indirect rather than direct taxation.
Presently there are different rates of VAT: standard (20%), reduced (5%), zero and products/services which are exempt.
Businesses with a taxable turnover of over £85,000 are legally obliged to register for VAT.
Registering for VAT in the UK
You can apply for a VAT registration certificate by creating a VAT online account (also known as a Government Gateway Account). You will need to supply details about your business’ turnover, business activity and your bank details.
You should receive your VAT registration certificate within 14 working days with information about your VAT number, when to submit your first VAT return and its payment and your ‘effective date of registration’.
Once you’re registered for VAT, you’re legally obliged to charge the right amount of VAT, pay VAT every quarter to HMRC, submit VAT returns and keep VAT business records.
Completing VAT returns
VAT returns are completed every 3 months (also known as the ‘accounting period’) and you should keep well-organised business records so that you’re able to fill in all the necessary details – your total sales/purchases, the amount of VAT you owe, the amount of VAT you can reclaim (for goods and services bought in order to operate your own business) and what the VAT refund from the HMRC is. You should submit your return even if you have no VAT to pay or to reclaim.
VAT returns can be submitted online using your 9-digit VAT number and your VAT online account. There is guidance available so you know what to put into each box but if you have any difficulties, there is a VAT Online Services Helpdesk.
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Making VAT payments and deadlines
There are different deadlines according to which payment scheme you belong to but you’ll be notified by HMRC. You can also sign up for email reminders if you are worried about the financial penalties for submitting your VAT return late because of an oversight.
You can sign up for email reminders if you are worried about submitting your VAT return late because of an oversight.
Generally, the deadlines are 1 calendar month and 7 days after the end of your accounting period. However, you must allow enough time for your payment to reach HMRC. Payments can be made through Direct Debit, through a bank or building society account or online using a debit or credit card. If you wish to use Direct Debit, this will take at least 3 working days to set up so don’t leave it until the last minute. To use a bank or building society to make VAT payments, you need to order pay-in slips from HMRC by phone or online. Online payments through CHAPS generally arrive the same or next day.
You can use your VAT online account to make sure your payment has been received; this information is updated within 48 hours.
Late VAT returns and the surcharge period
If you are late submitting your VAT return, you might enter a 12-month ‘surcharge period’. Although you don’t pay a surcharge for your first default, you will have to pay a surcharge on successive defaults. The amount depends on how many times you default in this period and the annual turnover of your company. Surcharges are usually calculated as a percentage rate on the outstanding VAT you owe and the rate increases if you default more than once.
You won’t pay a surcharge if you submit your VAT return late but you still pay your VAT bill on time or if you have no VAT to pay or you’re owed a VAT refund.
Summary:
You can apply for A VAT number online by creating a VAT account and should receive your certificate within 14 days.
Once registered for VAT, you must submit VAT returns every 3 months and this can be done online using your 9-digit VAT number.
You’ll be notified of your deadline for paying any VAT and there are a number of different methods of payment.
There are penalties for filing your VAT return late unless you pay on time, have no VAT to pay or are owed a VAT refund.
Questions:
How much revenue does the government collect from VAT?
According to IFS estimates for 2016-17, the state raised £120.1 billion from VAT (or 16.8% of total tax revenue) making it the third largest tax in the UK – after income tax and National Insurance.
How many businesses in the UK are registered for VAT?
According to an October 2016 report by ONS (Office of National Statistics), 2.55 million businesses were registered for VAT and/or PAYE in March 2016. This represents an increase of 4.3% compared to the previous year.
How much is VAT compared to other European countries?
Considering the complexity of the VAT system in the UK with varying rates, it’s difficult to compare VAT with other European countries. However, the standard rate of 20% isn’t the highest in Europe – Denmark, Sweden and Hungary charge 25% while Iceland tops them with a 25.5% VAT rate.
Can I backdate claims for VAT for business expenses I had before I registered for VAT?
You can backdate claims for business-related expenses with a time limit of 4 years for goods and 6 months for services. Like any expenses, you should have all the invoices/receipts and should complete Box 4 on your first VAT return. You’ll need to provide details with a description, a purchase date and how it relates to your business nowadays.
Financial penalties for VAT
There are a number of penalties regarding VAT payments, which can be as high as 100% of the VAT owed for careless or deliberate miscalculation of VAT owed by the business. Generally, you will be charged 2.75% interest on underpayment of VAT (or for overestimating the amount you can claim back). If you don’t pay the sum you owe within 30 days, further interest is charged for a maximum of 2 years.
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Like income tax, the penalties are severe since the money owed is money that you’ve already received when you charged your customers/clients for the goods or services. This is why it’s important to keep clear business records and set the money aside for your quarterly VAT payments.
Should I voluntarily register for VAT?
If your business makes less than £85,000 a year, you might be wondering why you’d voluntarily wish to register for VAT. However, it might be good business practice for you to register for VAT since it means you’re able to reclaim your input VAT (money you pay on goods and services needed to run your business). For example, businesses which sell zero-rated goods and supplies such as booksellers and food producers are able to reclaim all their input VAT. This means you may be able to reclaim more VAT from HMRC than you have to pay. (VAT can’t be reclaimed on products which are VAT-exempt, however).
Another factor to take into account is whether your business sells predominantly to the general public or to other businesses. Registering for VAT may not be worth it if you mainly sell to the public since the only effect may be to put up your prices and lose customers. On the other hand, other businesses might prefer doing business with you if you charge VAT since they’ll be able to reclaim it on their own return.
This is a decision which shouldn’t be taken lightly and before reaching a decision, it might be a good idea to consult an accountant or independent financial adviser to see what financial repercussions voluntarily registering for VAT would have on your business.
Alternative VAT schemes
Some businesses might be worried about the extra bureaucratic red tape of calculating VAT returns and making payments and how it can distract them from the day-to-day running of their business. To help these people, there are 2 main schemes which you can join to simplify matters: the VAT flat-rate scheme, the cash accounting scheme and the annual accounting scheme. Let’s look at them in more detail to see who’s eligible and how they differ from quarterly VAT returns.
The VAT flat-rate scheme
With the VAT flat-rate scheme, businesses pay a VAT flat rate of 4% to 14.5% depending on the average VAT rates for the industry they’re involved in and how much input VAT they have to reclaim. This single rate makes it much easier to calculate their VAT payments but they give up the right to reclaim VAT on inputs. Some eligible firms may end up paying more or less VAT under this scheme but they gain time in that they no longer have to keep such detailed records and don’t have to calculate the VAT for each business transaction separately. It’s often more beneficial for businesses which are selling their time and expertise rather than products.
The VAT flat-rate scheme makes it easier to calculate VAT payments for businesses but they give up the right to reclaim VAT on inputs.
To be eligible for the flat-rate scheme, businesses must have sales of under £150,000 (excluding VAT) but are allowed to remain in it unless sales exceed £230,000 (including VAT). It might be worth calculating your VAT under the standard rate compared to the flat rate or consulting a financial adviser before deciding whether to join the scheme.
Summary:
You should pay your VAT on time since there are financial penalties for late payments.
Whether to voluntarily register for VAT depends on how much input VAT you’d be able to claim and on your client base.
There are a number of schemes which allow you to calculate your VAT returns more easily.
The VAT flat-rate scheme allows you to pay a flat rate of VAT depending on your industry but you can’t claim input VAT.
The cash accounting scheme for VAT payments
To be eligible for the cash accounting scheme, you must have a VAT taxable turnover of no more than £1.35 million (until turnover exceeds £1.6 million). In this scheme VAT is paid according to the payments which have been received rather than on the standard invoice basis (which is when you’ve issued an invoice but haven’t necessarily been paid).
The VAT annual accounting scheme
To be eligible for the annual accounting scheme, you must be VAT-registered and with an established turnover of £1.35 million. Under this scheme you make advanced VAT payments towards your VAT bill. These advance payments can be monthly (or 10% of your established VAT bill) or quarterly (or 25% of your usual VAT bill). The final payment (or balancing payment) is made with the final VAT return or it could be a refund if you’ve overpaid the VAT you owe.
This scheme works well for established businesses with a regular turnover. However, if your business experiences seasonal variations and you encounter cash flow problems, it might not be ideal for you since VAT is only refunded once a year.
VAT and consumers
It’s doubtful whether you take account of VAT when shopping since most consumers only look at the bottom line: the final price of the products they wish to buy and how much they go up.
The only time when it becomes a concern is when you wish to pay for a service. Advertisements and catalogues which are intended for the general public show any prices as VAT-inclusive. However, if you ask for a quotation for a service, then you should be more cautious since VAT may not be included in their price lists. This is something to be aware of when you’re collecting quotations before making a final decision.
By law, invoices from suppliers such as builders and decorators must show a separate amount for VAT and should also show their VAT number. If you have any doubts, you can check online whether a VAT number is valid.
It’s possible to receive a refund of VAT on goods bought in the UK but only under certain circumstances. One of the most common is if you’re a EU resident leaving the EU for 12 months or longer. However, this tax-free shopping isn’t offered by all retailers and it’s only possible for goods purchased in the previous 3 months.
Questions:
How do increases in VAT affect tax revenue?
It has been estimated that every extra 1% increase in VAT brings in £4.5 billion in extra revenue.
Can I claim VAT from business entertainment expenses?
One of the most common mistakes business-owners make is trying to claim VAT on business entertainment. Although you can claim the VAT for staff (such as the annual Christmas party), you can’t claim for entertainment expenses for clients. There are also special rules regarding cars and staff travel expenses.
Can I reclaim VAT for bad debts?
You can reclaim the VAT from HMRC for non-payment of a bill. The debt must be from 6 months to 4 years, 6 months old and you mustn’t have charged more than the normal price for the goods or service.
If I pay too much VAT, do I receive interest on the money I’m owed?
Yes. The interest rate for overpayments of VAT is calculated at 0.5%.
The size of VAT avoidance, evasion and fraud
Calculating the size of the losses to state revenue from VAT avoidance, evasion and fraud can be difficult since HMRC can often only estimate from those who are caught. However, for 2013-14, it has been calculated that non-collection of taxes was £34 billion in total – £13.1 billion of which was unpaid VAT.
This figure includes criminal gangs operating ‘missing trader’ or carousel fraud as well as businesses which falsify their VAT tax returns. Recently, HMRC have been given new legal powers to tackle the problem of VAT evasion committed by foreign online retailers. This is estimated to have cost the taxpayer £1.5 billion in the year leading up to March 2016 as well as undercutting legitimate British-based businesses which do pay VAT. In an attempt to combat this problem, HMRC has allocated £22.5 million over the next 5 years to deal with this problem including a hotline or online tool to report suspected VAT fraud anonymously.
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