Outsourcing - VAT

VAT is one of the few taxation areas that applies equally to every business from the multi-million pound company to the sole trader.

VAT was introduced by the Government in 1973 as an indirect tax ultimately aimed at the final consumer of goods and services. It was not designed to impact on businesses as, when an invoice is raised, VAT is charged over and above the cost of the goods or services.

Currently in the UK there are three basic rates of VAT:-

17.5% is the most common and described as standard rate.
5% for reduced rate goods and services such as domestic fuel and power.
0% for essential items such as children’s clothing and insurance.

Registration

Once a business reaches the threshold of £64,000, or expects to breach this threshold in the next 30 days, the business is required to register for VAT and start charging VAT on their supplies. If the application for registration is not submitted within 30 days of reaching the threshold, HMRC may impose financial penalties on the company. Where the turnover of taxable supplies is less than £64,000 there is no requirement to register for VAT, although voluntary registration may be beneficial. The most beneficial aspects of voluntary registration are that if any VAT has been paid to suppliers, it can be offset against the amount of VAT due to HMRC for VAT charged to customers. Additionally once the company is VAT registered, it can take advantage of a number of simplification schemes run by HMRC which, under certain circumstances, may make additional profits for the company.

Once the registration has been accepted, HMRC will issue the company with a VAT registration certificate.

When is VAT payable?

VAT is payable on supplies of goods or services made within the UK by a taxable person in the furtherance of a business. If any of these three conditions are not met, then VAT is not chargeable.

There is no concrete definition of a taxable person but, in general, any individual or company carrying out business activities in the UK is classed as a taxable person.

How to add VAT

Once satisfied that VAT is applicable to the services/goods being supplied, three possible rates apply depending on the type of supply.

17.5% for standard rated supplies.
5% for reduced rate supplies.
0% for zero rated supplies.

In general, for freelancers the only time that the 0% rate will apply to their services is when work is being carried out on new build housing projects. The 5% rate is similar as this will generally only apply to certain renovations on dwelling houses. At all other times where VAT is applicable to the services, including improvement work carried out on existing houses, the rate to be used is the standard rate of 17.5%.

Once the correct rate for the supply has been determined, the VAT chargeable is calculated as the appropriate percentage multiplied by the net value of the services e.g. the number of days worked multiplied by the day rate.

How to pay HMRC

Under normal circumstances a VAT return will be due to HMRC every three months. The end of the first period is given on your VAT registration certificate and the return and any payment due should be paid to HMRC within one calendar month of the period end date. The due date for payment will be given on the VAT return.

If payment is made electronically HMRC grant the business an additional seven calendar days to submit the return and payment.

Calculating your VAT return

There are four methods for calculating the VAT due to be paid to HMRC.

1. Standard Method

The VAT payable to HMRC under this method is calculated as the VAT you charge less any VAT you have paid to your suppliers for business supplies.

For some items bought for business purposes special rules apply to the amount of VAT you may reclaim but in general this only applies to high value items which are likely to be a one off expense to the business.

2. Annual Accounting

Under the annual accounting scheme a business is only required to submit one VAT return per year. However, under normal circumstances nine payments on account are required, each representing 10% of the previous years VAT liability. This can be simplified further to three payments on account representing 25% of the previous year's VAT liability with written approval from HMRC. The balancing payment for any VAT due should be sent to HMRC with the VAT return for the year. All payments are required to be made electronically.
To be eligible to join the annual accounting scheme a business must either:-

Be in its first year of VAT registration and have taxable supplies expected to be less than £150,000.
Have been VAT registered for at least one year and have expected taxable supplies of £600,000 or less.

3. Cash Accounting

Under cash accounting VAT is accounted for when payment is received for an invoice rather than at the original tax point date. This will benefit the company’s cash flow position and is widely used by small businesses for this reason.

Eligibility is stricter than with annual accounting as there is a larger scope for error due to the timing aspect.

The company must have submitted all VAT returns due and payments before starting to use the scheme.
The company must not have been assessed for a penalty within the previous year.
Expected taxable supplies are less than £600,000 for the next year.
No money is outstanding to HMRC.

4. Flat Rate Scheme

The flat rate scheme is one of the most common schemes used by small businesses to calculate the VAT due to HMRC. This method differs from the standard method of calculation in that the VAT due is a fixed percentage of the gross sales of the business. The gross value includes the VAT added to the net value of the sales.

Percentages are set by HMRC across different business sectors and range from 2% to 13.5%. In general, businesses that would usually have high levels of purchases and therefore a high level of reclaimable VAT will have a lower flat rate percentage but where a business would typically have lower purchases and reclaimable VAT the flat rate percentage will be in a higher bracket.

For example, a manufacturing company would be required to buy a large amount of raw materials and as such general manufacturing is allocated a percentage of 8.5%. However, an accounting firm is likely to only make a few purchases and as such is assigned a percentage of 13%.

To be eligible to join the flat rate VAT scheme, taxable supplies for the next year must not be expected to be in excess of £150,000.

Once acceptance has been granted, turnover may increase to £225,000 before the company is automatically withdrawn by HMRC, however evidence of your initial estimate for turnover may need to be provided. This is based on the assumption that the business will grow over time.

The business can choose to withdraw from the flat rate VAT scheme at any time if it is no longer going to be beneficial i.e. if VAT due under the standard method is less than VAT payable under the flat rate scheme but conditions apply to rejoining the scheme at a later date. If the company is removed or chooses to withdraw from the scheme, the company must wait for one calendar year to pass before applying to rejoin the scheme.

Simplification methods can be used in conjunction with each other, although it is not possible to use Cash Accounting with the flat rate VAT scheme.

Outsourcing - VAT

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