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VAT – The Basics for SMEs

Smaller businesses and sole traders often feel overwhelmed when it comes to dealing with VAT (Value Added Tax) due to the sometimes confusing jargon involved so today we’re going to take a look at the basics of VAT to guide you through the complications and make sure you get it right.

VAT was first invented by the French in the 1950s and then became a tax to which all new members of the Common Market and European Union have to sign up on joining.  Here in the UK if your business turnover exceeds £83,000 in the previous twelve months, then you have to register for VAT.  However, it’s possible to register on a voluntary basis at any time, even if the turnover is below the compulsory threshold.  If you’re a VAT registered business then you must report to HM Revenue and Customs (HMRC) the amount of VAT you’ve charged and the amount of VAT you’ve paid.  VAT is charged on the following items:

  • Hiring or loaning of goods
  • Selling business assets
  • Business sales – goods and services
  • Commission
  • Items sold to staff, such as canteen food
  • Business goods used for personal reasons
  • Non-sales, such as bartering, part exchange and gifts.

VAT is added to sales invoices and if a supplier is VAT registered it will also be added to purchase invoices.  All VAT invoices will need to display information such as the VAT registration number.  

Most purchases and products incur a standard rate of VAT at 20% but some are chargeable at a reduced rate of 5% and some are even zero rated.   There’s a range of items that are exempt from tax or zero rated for VAT and you should know that the exact definition of a particular item can determine whether or not VAT is applied to it.  There are so many seeming inconsistencies when it comes to VAT and this has led to some heated debates between HMRC and businesses.  For instance, the infamous case of the humble Jaffa Cake which ended up going to a tribunal to be settled.  Cakes are exempt from tax while luxury biscuits have VAT applied at the standard rate.  McVities, who make Jaffa Cakes insisted that they are cakes, rather than biscuits, and the tribunal eventually ruled in their favour.

VAT Returns

Every three months, a business submits a VAT return online to HMRC.  Output tax (on sales) and Input tax (on purchases) are netted and the difference is paid over to HMRC.  Usually, outputs exceed inputs but in cases where inputs exceed outputs, HMRC will make a repayment.

When it comes to selling digital services to customers in other EU countries, a business can register for VAT in the EU state of its customer or complete a UK VAT MOSS scheme return every quarter – then it’s just a matter of making one payment to HMRC who pass on the correct share of the VAT to the VAT authority in each member state of the EU.  Many businesses here in the UK avoid the paperwork generated by this by selling their goods through a global platform such as Amazon.