The great VAT myth: Why it’s worth planning for it from day one

Financial Information

by David Fotheringham 22 Views 0

by Nick Whitmore

Updated: Dec 23, 2015 Published: Jul 16, 2013

I’ve had many discussions with other business owners, friends and family members on the topic of VAT. Most people are under the illusion that it’s just the by-product of a successful business. “Your customers pay it, not you”, they tell me. In my opinion and speaking from experience, that’s far from reality.

Value added tax (VAT for short) is a tax that’s applied to most things you purchase in the UK in the shops and online. Both new and second-hand goods are “VATable” – although there are some exceptions.

Any entrepreneur out there that’s worth their salt will be thinking about the growth of their business in a big, big way. With company growth comes increased revenue – and with more revenue comes the increased likelihood of your business needing to register to VAT.

At present companies turning over £81,000 (total of your sales within the UK & EU) or more on a rolling 12 month basis must register for VAT.

Let’s make one thing absolutely clear – you must register to charge VAT at this point. There are no exceptions (even if your business offers services or products that are VAT exempt, you must still register if you hit the turnover threshold).

Whether you’re a sole-trader, a limited company or you’re trading under any other legal business entity, you have to register to VAT once you hit the turnover threshold.

Some businesses opt to register for VAT from day one – this can be a wise choice because a lot of suppliers and B2B companies out there won’t look at your business twice if you’re not VAT registered. There are lots of reasons why, but registering for VAT suggests your business is going to stand the test of time.

Plan for VAT from day one

Many, many entrepreneurs and small business start-ups don’t plan properly for VAT. They think to themselves “VAT’ll never affect me!” – but that’s wrong. As I’ve already said, any entrepreneur worth their salt will aim to hit the VAT turnover limit in no time at all.

All business to consumer (B2C) outlets and businesses (shops, tradesmen, online stores, etc) must display prices including VAT (where VAT is applied) to customers.

If a customer pays £12 for a pair of trainers, the majority of the population don’t realise that £2 of that goes directly to HMRC – it’s VAT charged at 20%.

The problem for business owners that don’t plan for VAT is that when they do have to start charging it they hit a massive dilemma. Do they alienate a large number of customers by slapping a further 20% on retail prices? Or do they absorb VAT into profit margins – reducing them significantly?

Clearly charging VAT has various pitfalls that every business owner needs to be aware of. If you’re currently not VAT registered and you’re trading on slight margins of 1% – 20% net profit, your margins could be all but wiped out should you have to register for VAT (if putting up prices is not an option).

Even if you’re currently running on healthy margins and you plan to absorb VAT into those margins, you’ll have to sell 20% more to make the same net profit at the end of the day. Could your business still survive and thrive with a 20% decrease in net profit overnight?

VAT registration when you hit the turnover limit is not optional – it’s compulsory. Therefore VAT is something you’ll just have to get used to – something you have to plan for accordingly.

Are there any exceptions?

Yes – there are some exceptions. If you sell products or services on a B2B basis you’ll probably be far less affected by VAT registration.

The majority of medium and large businesses out there are VAT registered anyway – so they can reclaim any VAT that you charge on top of existing prices.

It’s not all doom and gloom, but realistically how many businesses out there supply the trade? Not a large percentage of the UK’s small businesses, that’s for sure.

The news that calls for slight optimism is the fact that the VAT turnover limit is gradually increasing. The VAT turnover limit was just £5,000 when VAT was first introduced in 1973 – it rose to £25,400 in 1990, by 2000 it was sitting at £52,000, and today it sits at £81,000 (source: ifs.org.uk).

Other news that calls for optimism is the fact that only turnover from within the EU is VATable. If your company turns over £100,000 per year but you only take £50,000 in sales from within the EU, you won’t need to register for VAT.

When your business is VAT registered you can reclaim any VAT that you pay – for example on stock, computers or other business purchases. You may even get a little VAT refund from the VAT man if your net VAT outlay is bigger than the VAT sum that you collected for that particular quarter!

Fail to prepare, prepare to fail!

When I first started out in business I understood that one day I’d have to register for VAT. I made appropriate arrangements that ensured margins never strayed below 30% – which meant even with the VAT man taken care of I’d still be working to 10% margins.

The fact my business was in a B2C environment meant I couldn’t just slap an extra 20% on prices due to competition – therefore I gradually had to increase prices in 5% increments until I reached the point of 20-30% margins once again.

It’s always worth hiring an accountant to look after the financial side of your business, if your budget allows. Accountants can offer sound advice when it comes to VAT registration and they can guide you through the process, and even look after VAT returns for you. If you can’t afford to hire an accountant then it’s worth booking a one-off meeting just to ensure you’re meeting all of your obligations in terms of VAT and general bookkeeping.

If your budget doesn’t allow for you to hire an accountant, HMRC’s website contains everything you could possibly need to know about VAT. Make sure you go over the VAT section carefully – if you do, you can’t go wrong!

Charging VAT can come as a huge shock for your business if you don’t take necessary steps when on the road to hitting the VAT threshold. Take my advice: Look into VAT registration today and start planning – it’ll make things a whole lot easier when your business really does start to hit a growth spurt.

Nick Whitmore is an entrepreneur and start-up business owner from North Wales. He specialises in website content writing through his website contentwriting.org , and also runs a cosmetics distribution business.

Comments