VAT 101 – Tests, Schemes, Returns and Errors

When To Register For VAT

When your taxable turnover reaches £85,000 then it is time to register for VAT. Now, there are two tests you need to consider in respect of registration: the historic test and the future prospects test. 

The Historic Test

Each month a trader must look back at the last 12 months and calculate whether they have exceeded the annual threshold of £85,000. If so, then it may be time to register to VAT. It should be considered whether this trend will continue though. If the trader expects to make under £83,000 for the following 12 months, then they need not apply. This is to aid smaller businesses who may have had just one particularly good year. If you register after applying the historic test, then you will need to register within 30 days of the end of the month in which the threshold was exceeded. So, if your business exceeds the VAT threshold on the 12th April 2019, you will need to register by 30th May 2019. 

The Future Prospects Test

If you expect to exceed the threshold within the next 30 days then you must register for VAT e.g. if you sign a contract that will take you above the VAT threshold. In this case, once registered, the VAT registration date will be from the beginning of that 30-day period. 

It should be noted that anyone trading could be liable to register VAT. This includes sole traders, if your taxable turnover exceeds £85,000, then as an individual, you will need to register for VAT. This is providing that you do not provide exempt supplies or services. Here are details of HMRC’s guidance on what supplies and services are considered exempt: 

  • Insurance, finance and credit
  • Education and training 
  • Fundraising events by charities
  • Subscriptions to membership organisations
  • Selling, leasing and letting of commercial land and buildings (please note that this exemption can be waived)

You cannot register for VAT if you provide exempt supplies. This includes reclaiming VAT on items purchased for the business. Partially exempt businesses can register for VAT however the rules differ slightly. A business is classed as partially exempt if the business has incurred VAT on purchases that directly relate to the exempt supply. This means you won’t be able to claim exempt input tax, unless it is below a certain amount. 

If your supplies are all zero-rated supplies, then you can apply for an exemption from registration. This however means that you will be unable to reclaim any VAT on your purchases. If you have not applied for an exemption to registration, then once you exceed the registration threshold you will still be liable to register. 

Once registered, all sales must have VAT charged and you must begin accounting for the VAT in your purchases and sales. You must also keep VAT appropriate records and retain those for a minimum of 6 years. 

If you need to change any of your details after registration, then HMRC most be notified within 30 days of said change. This could be anything from change of address to bank account details, penalties could be charged if you fail to do so. 

What VAT scheme to use? 

When it comes to accounting for VAT, there are several VAT schemes that you could use. The schemes are as follows: 

  • Accruals accounting 
  • Cash accounting 
  • Annual accounting
  • Flat rate scheme

Accruals Accounting VAT Scheme

Generally, most businesses operate on the accruals scheme. The accruals scheme is generally the usual quarterly VAT returns and any invoices or purchases made in the period will be included. As always with accruals, this means invoices raised rather then when money passes hands. So, any items that were purchased on credit will be included if the date of the invoice is within the period. 

Cash Accounting VAT Scheme

Rather then using the date the invoice was issued, the cash accounting scheme considers when the monies changed hands. The tax point for invoices becomes the date of payment, rather than the invoice date. In order to be applicable for the cash basis a business must have: 

  • Up to date VAT returns and no VAT offences or penalties
  • Their estimated taxable turnover for the next 12 months must not exceed £1,350,00 

Once included in the scheme the business will still have to keep an eye on their taxable turnover. If the business’ taxable turnover exceeds £1,600,000 then they must leave the scheme and account for their VAT via the accruals method. When a business does move from cash to accruals, they must account for all VAT outstanding, in order to avoid any confusing overlaps. 

Annual Accounting VAT Scheme

This scheme can be used in conjunction with the cash basis. The annual accounting scheme has been introduced to alleviate the burden of having to prepare quarterly invoices for smaller businesses. The scheme allows the scheme users to submit one annual VAT return, this usually coincides with the accounting period of the business. The conditions in order for a business to become part of the scheme are: 

  • Up to date VAT returns and no VAT offences or penalties, however businesses do not need a VAT history, they can sign up immediately after registration 
  • Taxable turnover is under £1,350,000 and will not exceed this in the next 12 months 

Once the period is over, the business will have 2 months to submit their return. If there is a balancing payment to be made, this must be paid when the return is filed. Businesses on the scheme will have to make 9 monthly payments on account from the 4th to 12th month of the period. As the revenue do not know the liability, the payments on account are set up very similarly to self-assessment. It takes the previous years liability and splits it into 9 payments, the difference being paid upon submission of the return.  All payments must be made electronically and there are no extensions available.   

Flat Rate VAT Scheme

The flat rate scheme again is available to smaller businesses. It was introduced in order to simplify VAT for smaller businesses, as it could potentially reduce administrative costs. Flat rate is calculated by applying the percentage to total sales (including exempt supplies). In the first year of using the scheme the business will receive a 1% discount. Now, businesses on the flat rate scheme cannot reclaim VAT on purchases (unless a capital item), so it is always best to consider what method would be most appropriate for your business. It is, however, possible to end up paying less tax on the flat rate scheme, as usually the fixed amount is 16%, which is obviously 4% less then the standard rate of tax.   

Submitting VAT Returns 

Now with making tax digital (MTD) you should be using accounting software which is MTD compliant in order for you to submit your returns. All of your records should also be kept digitally. Please bear in mind that you can still retain your paper invoices and while it is highly advisable that you do, they must also be entered into your accounting software.  

Most businesses process their VAT returns quarterly. You have a month and 7 days following the end of the quarter to submit your return and make payment of any VAT you may owe. You can set up a direct debit with HMRC which will be taken from your account after submission of your return. This can be easier as you do not need to worry about making the payment. 

VAT Errors and Omissions 

Whether it be a miscalculation or an omission of a sales invoice, any errors or omissions must be accounted for. In some cases, you may be able to amend the error in your next return, however the error must meet certain conditions. In order to be able to amend an error in your next VAT return it must: 

  • Be non-deliberate
  • Be no more than £10,000 
  • Be between £10,000 and £50,000 but no more then 1% of the turnover for the period the return is for
  • Relate to an accounting period less than four years ago

If the error does not meet these conditions, then it must be submitted by a 652 form (can be found on HMRC’s website). If no form is available then the business must write to HMRC to voluntarily disclose the error. In this letter they must provide full details of said error, how it came about, the amount, the VAT period in which it occurred, how you came to realise said error and whether the error is in the favour of the business or HMRC. For larger errors it is essential that the 652 form or letter are used, however, you can still use the form if you have a non-deliberate smaller error. 

In some cases, HMRC might discover errors. HMRC have up to 4 years after a return is submitted to issue an assessment in relation to the return.  However, this can be extended to up to 20 years if the error is deliberate.  Penalties for errors that HMRC have discovered are likely to be higher than those voluntarily disclosed by the taxpayer. So, if you have realised you’ve made an error, disclose, disclose, disclose!  

However, sometimes things do happen and there is a reasonable excuse as to why your return or payment are late. These things could include a computer breakdown just before or during the preparation of the return or a loss of records due to uncontrollable circumstances (like a fire), if the only trained employee becomes ill and cannot prepare the return or if suddenly there is a lack of funds i.e. a large customer goes out of business or theft. HMRC needs to be contacted as soon as possible in any of these circumstances and the penalty may be waived due to reasonable excuse. 

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