There was a time when every accountant would caution their small business client about the perils of VAT. The fact that it means prices are inflated by 20% (the current standard rate) and that it costs more in time and hence money through having to compile quarterly returns to HMRC.

In this new digital age however, where many businesses run their accounts through digital accounting software, VAT returns can be completed automatically on-line with little time or fuss and there can even be financial advantages for businesses in being VAT registered.

In addition, there can be benefits to a business being VAT registered – if where it doesn’t need to be by law.

ON THIS PAGE
What is VAT & how does it work?
The main VAT schemes
Advantages & Disadvantages
Which is best for you?
What is VAT?
  • VAT (currently 20%) is a tax that must legally be applied to most goods and services that we buy.
  • Some goods and services are exempt from VAT for example insurance, postage stamps, health services, charity donations, children’s clothes, most food items, books, and newspapers
  • Some goods and services have a reduced rate applied (currently 5%) for example home energy, children’s car seats

 

This means that as a business almost every product or service that you buy (unless the supplier earns less than £85,000 per annum and has chosen not to register for VAT), will have had VAT added to it.

How does VAT work?
  • Regardless of whether your business is VAT registered or not, you will likely be paying VAT on many of the goods and services that your business buys in
  • If you are not registered for VAT yourself, you cannot claim back any VAT you pay to your suppliers
  • If your business is registered for VAT you must allow for 20% VAT to be included in the sale price of your goods or services but – depending on the VAT scheme you have registered for, you may be able to claim back VAT you have paid to your suppliers, thus reducing the overall payment to HMRC
The main VAT schemes
Full VAT Rate
  • You will pay VAT on all purchases
  • You will charge VAT on all products and services
  • You will file a return every quarter to HMRC that shows a detailed record of your costs and sales
  • You will pay HMRC the difference between the VAT charged and the VAT paid
Flat Rate VAT
  • You will pay VAT on all purchases
  • You will charge VAT on all products and services
  • You will file a return every quarter to HMRC that shows a detailed record of your sales
  • You will record all your purchases as out of scope of VAT, 
  • You will pay HMRC VAT based on a rate that is set and agreed and based on your business type. This is often considerably lower than the standard rate.

For hotels and accommodation providers this is generally set at 10.5%

For catering services and restaurant this is generally set at 12.5%

For pubs this is generally set at 6.5%

For travel agencies this is generally set at 10.5%

Up to date rates can be found here with the VAT Flat Rate Scheme

As an example – if you are a hotel that charges £100 for a room for a night. You will charge VAT @ 20% which equates to £20 making the total bill to the customer £120.

In normal circumstances the rate for your hotel using the Flat rate is 10.5% and so your flat rate payment will be 10.5% of £120 which is £12.60

Advantages & Disadvantages

There are advantages and disadvantages for being registered and not being registered and to extent these will depend on your business and customers.

Non Registered
Advantages
  • Less paperwork
  • Prices are 20% less for non-business customers
Disadvantages
  • Can’t claim back VAT on purchases
  • Cannot turnover more than £85k per annum
  • Possible monthly limited means the business shuts
  • Can make a business appear less successful
Registered – Flat Rate
Advantages
  • Simple VAT returns
  • Prices are 20% less for business customers
  • Can improve the image of the business
Disadvantages
  • Can’t claim back VAT on purchases
  • Cannot turnover more than £150k per annum
  • Prices could be more expensive for non-business customers or profits are reduced

 

Registered – Normal Rate
Advantages
  • VAT can be claimed back on purchases
  • No limit on sales
  • Digital returns possible
  • Can improve the image of the business
Disadvantages

  • Prices could be more expensive for non-business customers unless you take a lower profit

How to work out whats best for you?

As you can see there are both advantages and disadvantages for all schemes and it will be important for you to consider what is most important to your customers and how your business operates.

Questions to ask include: –

  • In the visitor economy sector, it is unlikely that a non-business consumer will think twice about whether a business is VAT or not when considering their stability or quality of service. If most of your business is aimed towards non business consumers, then this is no longer an advantage to being registered. Your customer is more likely to be attracted by price.
  • However, if a high percentage of your business is geared towards hosting business events or business accommodation for larger VAT registered businesses, then VAT on your price is unlikely to be an issue as they can reclaim this cost. And they may feel that your venue is more stable financially if it is over the VAT threshold which may make it more attractive.
  • How much of your business cost is a fixed overhead where you wouldn’t be able to reclaim VAT on purchases and how much relies on you buying in goods that enable you deliver your product or service? For example, a Bed and Breakfast establishment will most likely have limited physical purchases related to each sale. Aside from the ingredients for breakfast most of the costs will come under overheads. An Events company however will likely be buying in a high proportion of Vatable supplies to deliver each event and may have low overheads. In this case it would be advantageous to be able to claim VAT back.
  • Is your business steady in terms of premises or equipment you need, or will you need to buy larger space or bigger and better equipment for your business to grow? If the former then there are no benefits to being VAT registered, but if the latter, there could be considerable savings through being able to claim VAT back that will help facilitate your growth ambitions.
  • With some businesses there will be a point where a business can increase its sales without having to increase its overheads (it will just be the cost of sales that increase) and can reach a point where it becomes profitable to be VAT registered. A hotel running at full occupancy vs a hotel running at 65% occupancy for example. How does this work?
    • Where this ‘scale up’ means that the net profit increases by more than 20% of the VAT threshold (£17,000 or more)
    • For example, a hotel may currently have most of its sales from leisure tourism, restaurant bookings, spa treatments and weddings. They have decided to try and fill the empty space from the quieter days of the weeks and months with business travellers and events. This doesn’t increase their overheads at all (the space and staff are already there) and their cost of sales increase is also minimal in relation to the sales price. By testing the scenarios, they will be able to tell how many extra events, business room nights per annum they will need to be able to recover the cost of VAT and start benefitting from being over the VAT threshold. This then becomes their target in their marketing efforts.
    • Scenario testing in this instance could be looking at: –
      • Remaining competitive for their consumer clients by maintaining the sales prices and absorbing the 20% VAT from certain elements of the services – such as spa treatments, bar and menu prices and wedding packages, but adding VAT onto accommodation and event spaces. By forecasting the percentage of business split, what does this do to the figures?

 

Ultimately there are lots of variables to consider, but the one thing we would urge is that you don’t automatically shy away from the VAT discussion. Talk to other business owners in your field. What are they doing and why have they made the decisions they have made? Talk to your accountant or other financial experts.