VAT is an ever-present headache for small business owners, who are often left wondering how much they should be charging or whether they even should be charging it at all. Luckily, the rules of VAT and how to calculate it are straightforward. VAT is added to most products sold by VAT-registered businesses in the UK, covering hiring or loaning goods to someone, items sold to staff, business goods used for personal reasons, and non-sales such as bartering, part-exchange, and gifts.
Exempt goods and services include financial services, investments, and insurance, as well as healthcare and medical treatment. Funeral plans, burial or cremations, charity donations, goods bought outside the UK, statutory fees, and goods sold as part of a hobby are seen as ‘out of scope’ and won’t need a VAT charge. Businesses must register for VAT if their turnover is more than £90,000 per year, to adhere to Making Tax Digital.
VAT Registration and Returns
Businesses must keep records of VAT on things they buy for their business and account for VAT on any goods they import into the UK. A VAT return must be sent to HMRC every three months, which is a form that tells HMRC how much VAT has been paid and how much has been charged. Even if there is no VAT to pay or reclaim, a VAT return still needs to be filed.
The standard 20% VAT rate doesn’t apply to everything sold. Some items are reduced VAT, such as fuel and certain health products, while others are zero-rated VAT, including unprocessed human food and drink. To calculate VAT, businesses can use a calculator to divide the total amount by 1 plus the VAT percentage. For example, if the VAT is 20%, the total amount is divided by 1.20.
Calculating VAT
A £200 item divided by 1.20 is £166.67, and if £166.67 is subtracted from £200, that leaves £33.33, which is the VAT. VAT is paid through the VAT return every three months. If a business is using the flat rate scheme, it pays a fixed rate of VAT to HMRC and keeps the difference between what it charges and what it pays.
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However, under the flat rate scheme, businesses can’t reclaim the VAT on purchases, except for certain capital assets that are over £2,000. The flat rate paid depends on the type of business, and the tax paid is calculated by multiplying the VAT flat rate by the ‘VAT inclusive turnover’.
Common Mistakes and Advice
Chartered accountant Nicole Zalys from The London Accountant advises that good record-keeping is essential for getting VAT right. Businesses should ensure invoices clearly show the net amount, VAT rate, VAT charged, and total amount, and regularly check that the figures recorded in their accounting software match the original invoices and receipts.
Accounting software can reduce basic calculation and administrative errors, but it shouldn’t replace an understanding of the figures. Business owners should review their VAT records regularly and investigate anything that doesn’t look right. VAT can become complicated when dealing with unusual transactions or overseas customers and suppliers, so getting professional advice at the outset can be easier and less costly than trying to correct a VAT mistake later.
Jane Stacey, VAT partner at Xeinadin, notes that VAT mistakes are easy for SMEs to make because the person doing the VAT return often manages multiple tasks. Mistakes can sit unnoticed and repeat themselves over a longer period. Reclaiming VAT can create similar problems, especially for owner-managed businesses that pay for expenses with both business and personal use.
SMEs need to take care regarding the information going into their accounting software, as an incorrect VAT code or incomplete invoice can be repeated hundreds of times before anyone notices. Regular checks are far easier than correcting a quarter’s worth of transactions later, and errors may lead to interest and penalties.
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HMRC’s Transformation Roadmap makes it increasingly important for SMEs to review their systems, VAT coding, invoice approvals, and customer and supplier data. With mandatory e-invoicing for business-to-business and business-to-government transactions due from April 2029, SMEs should use this time to prepare and ensure their VAT records are up to date.
For small businesses, it’s essential to keep VAT records up to date and raise questions as they happen. For one-off or non-core transactions, such as selling an asset, professional advice should be taken to avoid costly mistakes. By following these guidelines and seeking advice when needed, small businesses can handle the complexities of VAT and ensure they are in compliance with HMRC regulations.
They must understand how to calculate VAT and keep accurate records to avoid mistakes and penalties.
Small businesses should also be aware of the different VAT rates and exemptions to ensure they are charging the correct amount.