The complete guide to understanding VAT returns for small businesses in the UK. Our presentation includes: VAT principles and how VAT is collected, the different types of VAT rates and categories they apply to, how VAT returns are calculated for small businesses selling exempt products, VAT registration rules and advice, the three VAT schemes explained, useful real-world examples and much more.

1. UNDERSTANDING VAT FOR
SMALL BUSINESSES:
AUGUST 2013

2. Understanding VAT for Small Businesses
The principles
• VAT stands for Value Added Tax
• VAT is a form of indirect taxation
• Standard rated VAT tends to be on the majority of services and products that
are seen as discretionary / non-essential purchases
Principles
How it works
for VAT registered
companies
• VAT is due to HMRC on certain sales (outputs) and recoverable from HMRC
on certain purchases (inputs).
• VAT registered entities have a duty to complete VAT returns “usually
quarterly”
• VAT returns now submitted online (paper returns no longer accepted)
• Principle is that if output tax exceeds input tax, the business pays the excess
to HMRC, but equally if input tax is less than output tax a refund is due
• Standard VAT rate is 20% and is payable on most of products and services
• There is also a 0% VAT rate (zero-rated) on certain items i.e. Children’s
clothes
• Some services are exempt e.g. insurance
• Some items have a different rate e.g. 5% rate for the supply of electricity
How it works
for consumers

3. Understanding VAT for Small Businesses
VAT bill is ultimately picked up by the consumer;
But collected in stages throughout the supply chain
WHOLESALER MANUFACTURER CONSUMER
• Gail chops down a tree
and turns it into timber
• She sells it to Ollie for
£400 + VAT
• £400 is Gail’s income
• £80 is VAT payable
• Ollie turns the timber
into a sofa
• He sells it to Duncan for
£1,000 + VAT
• £1,000 is Ollie’s income
• £200 is VAT payable
RETAILER
• Duncan runs a furniture
shop
• He sells it for £2,000 +
VAT
• £2,000 is Duncan’s
income
• £400 is VAT payable
• The consumer pays
£2,400
• Because he is not VAT
registered, he can’t
reclaim the tax
HMRC
•Paid: £80
•Reclaimed: £0
•HMRC net: £80
HMRC
•Paid: £200
•Reclaimed: £80
•HMRC net: £120
HMRC
•Paid: £400
•Reclaimed: £200
•HMRC net: £200
HMRC
•Paid: £400
•Reclaimed: £0
•HMRC paid by retailer
£400 collected in 3 stages
throughout the supply chain

4. Understanding VAT for Small Businesses
Quiz: Using the principle of VAT being applied to “non-essential” items,
allocate these to Standard rated, Zero rated, exempt and outside the scope
And the answers are…
Newspapers
Fruit & Vegetables
Meal at a restaurant
Salaries
Education
PAYE
Cakes
Biscuits
Accountancy
Residential rent
Alcohol
Water Postage stamps
Charitable donations
Hot food
Cold food

5. Understanding VAT for Small Businesses
Answers
STANDARD RATED ZERO RATED EXEMPT OUTSIDE THE SCOPE
Newspapers
Fruit & Vegetables
Cold food
Biscuits
Meal at a restaurant
Postage stamps Salaries
Accountancy
PAYEResidential rent
Alcohol Water
Education Charitable donations
taxed
elsewhere
So how are Zero Rated items and Exempt items treated on a VAT return?
Hot food Cakes
“discretionary”
items
“essential”
items
cash-like
items
(+ education)
Trivia: In 1991 HMRC attempted to reclassify Jaffa Cakes as biscuits. They lost and thankfully Jaffa Cakes are still VAT free.

6. Understanding VAT for Small Businesses
Companies that only supply VAT exempt products or services
cannot reclaim VAT on their expenses
Normal VAT
registered business
PAYS VAT ON: RECLAIMS VAT ON: EXAMPLE:
• All products and
services
• All supplies and
expenses which are
standard rated
• Furniture retailer handing over
VAT on consumer purchases
but reclaiming VAT on cost of
goods sold
Business that
supplies
VAT exempt
products
• Nothing • Nothing (not allowed
to reclaim VAT on
normal standard
rated items)
• Company set up sub-let
residential property e.g. not
VAT paid on sub-rent, but
cannot reclaim VAT on normal
office expenses
Business that
supplies both VAT
exempt products
and standard rated
products / services
• Only standard
rated products /
services
• Purchases directly
connected to
standard rated
products / services +
an apportionment of
shared expenses
• Company that provides sub-let
serviced accommodation with
laundry and catering services
• VAT only reclaimable on
laundry and catering direct
costs and a portion of shared
VATable expenses
Businesses that sell VAT exempt products can’t reclaim VAT,
but those with zero rated products can

7. Understanding VAT for Small Businesses
When should you register for VAT?
• Entities must register for VAT if their turnover goes over £79,000When do you need
to register
for VAT?
• Small companies that sell to consumers have a price advantage over bigger
competitors because they effectively charge 20% less
• Companies that provide VAT exempt supplies cannot VAT register
Does it make
sense to
register before
you need to?
Are there any
disadvantages or
restrictions?
• Registration is voluntary at any stage below £79,000 if you make standard
or zero rated supplies, this is advantageous for:
• Zero rated suppliers (e.g. greengrocers) as they will receive regular
refunds from HMRC because their outputs will be nil
• Start ups with significant VATable expenditure but with limited initial
revenue (which will help ease cashflow)
However, being registered for VAT, doesn’t stop certain items being “Blocked”
i.e. where VAT is charged but not recoverable on your VAT return

8. Understanding VAT for Small Businesses
Blocked VAT is where VAT is charged but not recoverable on your VAT return:
pick out the two blocked input VAT items
And the answers are…
Motor Cars
Telephone
Client Entertaining
Travel
Food
Legal fees
Rent
Computers
Insurance
Gas & Electricity
Staff Entertaining

9. Understanding VAT for Small Businesses
Blocked VAT is where VAT is charged but not recoverable on your VAT return:
pick out the two blocked input VAT items
Motor Cars
Telephone
Client Entertaining
Staff Entertaining
Travel
Food
Legal fees
Rent
Computers
Insurance
Gas & Electricity
Effectively inflates the price of these types of expenses by 20%
Note: In the case of leased motor cars only 50% of the VAT can be reclaimed i.e. 10% unless the car is exclusively for business use like a pool car

10. Understanding VAT for Small Businesses
There are three main VAT schemes
each with pros and cons
• Mostly commonly used
scheme
• VAT declared on outputs and
inputs when invoices are
raised
Accrual
Flat rate
Cash
FEATURES PROs CONs
• Flat rate percentage of
revenue based on
service/product provided
• Percentage advised by HMRC
is then multiplied by gross
turnover.
• Maximum of £150k net
turnover
• VAT declared on outputs and
inputs when the cash is
actually paid
• £1.35m net sales limit
• Easy to prepare by just
including transaction by
invoice date
• Low accountancy costs
• All accounting software can
deal with this scheme
• Need to pay VAT before cash is
received
• Cash flow issues e.g. if large sales
invoice in period
• Bad debt risk – takes at least 9
months to reclaim VAT if an invoice
is never paid by a customer
• Cash flow benefit as only pay
VAT when it is actually paid
• No bad debt risk
• Time consuming to administer as
VAT return requires different dates
to annual accounts
• Not all software supports it
• VAT bills arguably more likely to
fluctuate vs accrual method
• Potential cash saving
• Very easy to administer
• Can also be prepared on cash
basis
• Only available to smallest
businesses
• Must continuously monitor costs to
make sure still most cost effective
scheme, e.g. if supplier starts
charging VAT
• Slightly more difficult to administer
in terms of annual accounts
Cash scheme generally better for small business;
Accrual scheme generally easier for accountants!
Key difference is
timing of invoices

11. Understanding VAT for Small Businesses
Flat Rate Scheme means that VAT is paid on Revenue
at a certain percentage (determined by your industry)
The flat rate of VAT is determined by industry as
follows:
• Accountancy 14.5%
• Advertising 11%
• Estate Agents 12%
• Farming 6.5%
• Hotels 10.5%
• Pubs 6.5%
In addition, you can re-claim the input VAT at the
normal rate on capital items over £2,000 (gross).
FLAT RATE PERCENTAGES
• Technically speaking companies will benefit from
the flat rate if their VATable supplies are less than:
• 20% minus (20% - applicable flat rate)
• Divided by 20%
• Multiplied by their VATable revenue
• Hotel example
• 20 % - flat rate = 20% - 9.5% = 10.5%
• Divided by 20% = 52.5%
• Multiplied by revenue of £100k = £52.5k
so in this case if the value of the Hotel’s VATable
supplies are less than £52.5k, then they will
save money by opting for a flat rate scheme
WHEN TO OPT FOR THE FLAT RATE
Generally, any business owner who suspects he or she has a lower cost
structure than average should consider it (but remember the £150k limit)

12. Understanding VAT for Small Businesses
VAT Flat Rate Scheme
Estate Agent Worked Example
Net revenue*: £120,000
Wages (40,000)
Rent - exempt (15,000)
Telephone* (2,400)
Computer* (3,600)
Travel (1,500)
Accountancy* (7,200)
Profit: £50,300
Note: * VATable item
All figures net of VAT
ESTATE AGENT EXAMPLE
ACCRUAL SCHEME
•VAT payable: £24,000
•VAT reclaimable: £2,640
•HMRC net: £21,360
FLAT RATE SCHEME
•Net revenue: £120,000
•Gross revenue: £144,000
•VAT payable: £17,280
•Less computer: £720
•HMRC net: £16,560
£4,800
saved by flat
rate scheme

13. Understanding VAT for Small Businesses
Commercial property transactions can be optionally taxed
Option to tax:
•If supply of building/land is exempt can opt
to tax
•i.e. opt to treat as a taxable supply and
charge VAT
Implications:
• Standard rated VAT will be charged on
sale or lease
• Input tax relating to supply may be
recovered
• Once made option applies for 20 years
• If land/building is sold where option to
tax has been made, VAT needs to be
charged on sale of land/building
• Construction of new commercial
building
• Sales of new commercial building
under 3 years old
• Work on existing commercial
building
• Sale of old commercial building
(over 3 years old)
• Lease of commercial building
• But option to tax is available
Option to tax is only useful if a landlord
has significant other VATable expenses
Standard rate on
Commercial
Buildings
VAT exempt on
Commercial
Buildings

14. Understanding VAT for Small Businesses
Summary
• VAT is ultimately charged in full to the consumer, but it is collected in stages
throughout the supply chain
• VAT was intended to apply to all non-essential items and children’s shoes,
water and certain types of food are still exempt
Principles
For Small
Businesses
Special
cases
• Businesses that sell VAT exempt products can’t reclaim VAT, but those with
zero rated products can
• VAT registration is required over £79k turnover
• There are three VAT schemes: Accrual, Cash and Flat rate each with pros and
cons
• Owners of commercial property can opt to apply VAT if they have significant
VATable operating expenses

15. Understanding VAT for Small Businesses
Thanks
Thank you for reading!
Need further help with the preparation and completion of
your VAT returns? Our team are happy to answer any of
your questions.
Contact Us
Accounts and Legal Ltd.
20 Kentish Town Road,
London, NW1 9NX
0207 043 4000
info@accountsandlegal.co.uk
YOUR TEAM

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