Value Added Tax (VAT) is levied on almost all goods and services that are supplied in the UK. It is an almost universal tax on business transactions.
Rates of VAT
The standard rate of UK VAT is currently 20%, although there are also 5%, 0% and ‘exempt’ rates which are used for other purposes.
How to register for VAT
If you are a limited company contractor, you are obliged by law to register your company for VAT if your turnover has exceeded £85,000 over the past 12 months (from April 1st 2020), or if you expect to breach this threshold in the next 30 days alone.
Most contractors register for VAT as soon as they start working, as there are a number of benefits for doing so; it may provide your company with a more professional image to clients and agents and will enable your company to claim back the VAT on purchases.
How does Value Added Tax work?
As a limited company contractor, your company will pay VAT on any purchases it makes (input VAT) and will charge VAT on everything it sells to other companies – such as professional services (output VAT).
Each quarter, if you have charged more output VAT than you have spent in input VAT, you must pay HMRC the difference.
On the ‘standard’ VAT scheme, you account for VAT as soon as you create an invoice (i.e. you may have to repay the VAT to HMRC amount before you actually receive payment from a client).
For cash flow reasons, you may elect to join the cash accounting scheme, whereby you only account for VAT once you have been paid. You should check with your accountant which VAT scheme is most beneficial to you.
All VAT-registered businesses must add standard VAT at the prevailing rate to all invoices it produces.
Most contractors (or their accountants) will receive a VAT reminder every quarter. Your basic VAT calculations and payment should be returned to HMRC no later than one month following the end of your VAT quarter.
Most contractor accountants will take care of VAT calculations on your behalf. They will either let you know your VAT liability for you to pay direct to HMRC or in some cases, you will send the funds to your accountant to settle with the tax authorities on your behalf.
Since changes were implemented on 1st April 2010, all VAT-registered businesses must submit their returns online and make their quarterly VAT payments electronically.
You (or more likely, your accountant) must be signed up to HMRC’s VAT Online service in order to submit quarterly VAT returns, get reminders of when your VAT is due, and to set up a direct debit to automatically take your due taxes out of your business bank account.
Flat Rate VAT?
You may also be interested in registering to join the Flat Rate VAT scheme which could save you money if you do not claim a great deal of input VAT, although this benefit has been removed for many contractors from April 1st 2017 – read the article for details.
Eligible businesses also receive a discount to their flat rate percentage during the first year, which could result in a significant tax saving for your company.
This article provides a very high level outline of VAT. For more details, please read HMRC’s VAT pages.