The first thing you’ll need to do once you register for VAT is to add your VAT number to all of your invoices. The additional tax that you charge to your customers also, of course, needs to be recorded accurately on those invoices.
The amount of VAT tax you’re obliged to charge depends on the products you sell. Some products are exempt from tax, while others are zero-rated – a subtle difference your accounting needs to reflect. The standard VAT rate is currently 20 percent, but products in certain categories qualify for a reduced rate of five percent. To get additional guidance on how to apply VAT to specific items sold, check here.
VAT: Input Versus Output
It’s important to remember that the purpose of VAT isn’t to reduce your profits. The tax is being paid by the buyer. That means your customer – but remember that your business becomes the customer when you buy supplies.
When businesses make supply purchases and pay VAT on them, the tax is referred to as “input VAT.” This distinguishes tax paid from the tax collected from customers, which is called “output VAT.” This is important because the amount you need to send to HMRC every quarter is derived by subtracting input VAT from output VAT.
To clarify things a little, take a look at this example:
Say your store sells a table at a basic price of £60. You add 20 percent for the standard VAT, resulting in a sale price of £72. This is what your customer pays, and £12 of that is output VAT.
You bought the table from a supplier, paying £24. This is £20 for the dress and £4 of output VAT – paid by you.
The supplier constructed the table out of materials she bought for £9.60, a sum that includes £1.60 of output VAT paid by the supplier.
Once the chain of purchases is complete, here is where the VAT goes:
For the seller who supplied the raw materials, subtracting input VAT from output VAT results in £1.60 paid to HMRC (£1.60 – £0).
For your supplier, subtracting input VAT from output VAT results in £2.40 paid to HMRC (£4 – £1.60).
For you, subtracting input VAT from output VAT results in £8 paid to HMRC (£12 – £4).
Add up all the payments made to HMRC – £1.60 + £2.40 + £8 – produces £12, the same amount of VAT charged on the retail cost of £60. The input/output VAT accounting simply spreads this tax across the whole supply chain.
When you’re ready to reclaim VAT on your business’s expenses, the key document you need is a VAT invoice. A proper one includes all of the following information:
* Supplier’s name and address
* Supplier’s VAT registration number
* Supplier’s invoice number
* Total cost (not including VAT)
* Amount of VAT charged
* Details of the product/service provided
Use online access to your HMRC account to track the VAT refunds owed to you. You can claim these by submitting your return online, and your refund should reach you in 10 days or less.
When You Can’t Reclaim VAT
You can only claim VAT back on business-related expenses. If you make a purchase that is used for both personal and business purposes (e.g. a phone contract), you can only claim VAT on the portion you use for the business. This post from VATIT shows how it’s done.
There are other classes of expense that you are not allowed to reclaim VAT on. Examples include:
* Business entertainment expenses
* Supplies and materials purchased to create VAT-exempt products
* Purchases made from suppliers outside the UK (Note you may be able to reclaim VAT charged for EU purchases if you are eligible for the electronic cross-border refund system)
* Goods purchased through a VAT second-hand margin scheme (These schemes tax the difference between your buying and selling price on an item instead of the full selling price)
One bit of good news: You may be eligible to reclaim VAT on goods and services you bought prior to registering for VAT. This opportunity has a time limit, though. The VAT paid on services must be claimed within 6 months; goods you still use (or which you used to create goods you still use) can be claimed for up to four years.