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How does VAT work for micro-entrepreneurs in the UK?
4 November 2022
If you’re a micro–entrepreneur or run a small business in the UK, there are certain rules you need to follow in terms of VAT (Value Added Tax) for an effective retail accounting. The regulations are related to your annual turnover. This guide tells you what you need to know about paying VAT in the UK.
- What is VAT and how does it work?
- How much VAT should I charge?
- What is the VAT threshold in the UK and when do I have to complete my returns?
- How do I register for VAT?
- What VAT accounting scheme should I choose when registering?
- What are the benefits of registering for VAT?
- Can I be self-employed and VAT registered?
- What happens if I submit or pay my return late?
- What are the penalties for not paying or paying too little VAT?
- What if I pay too much VAT?
What is VAT and how does it work?
VAT is a UK tax that is charged on the purchase of most goods. The current standard rate is 20%, however, some products have different rates:
- Reduced-rate goods and services e.g. children’s car seats, sanitary products and home energy – 5%
- Zero-rated goods e.g. most food, books and children’s clothes – 0%
How much VAT should I charge?
If you have a store or run a service in the UK, you will have to check with the Inland Revenue (HMRC) what the correct rate is for the goods you are selling.
Example: VAT on sunglasses
You decide to set up an online store from your home in the UK selling sunglasses and will need to charge VAT as your expected income is going to be over the VAT threshold (see below).
Cost price (the price you buy the product for) £15
Retail price (the price you want to sell at) £45
VAT adding 20% to the retail price (multiply RP x 1.2) £54
Therefore, you will have to sell the glasses at £54 to make a profit of £30 per item and still charge VAT.
*Note – marketing psychology uses price points below the rounded figure, so if you wanted to sell the sunglasses at £49 you would have to work the VAT backwards.
You can also use a VAT calculator to determine how much VAT you should pay. There are many online VAT calculators to choose from.
The VAT you have charged customers is payable to the UK government when you do your HMRC VAT return. It is a way for the government to earn revenue for goods sold.
What is the VAT threshold in the UK and when do I have to complete my returns?
VAT has to be registered and paid if your business’s turnover for the last 12 months was over £85,000.
You are allowed to earn up to this amount before you have to register for VAT. The 12-month rule does not follow the tax year (which begins in April). It is therefore important to keep a log of your turnover to ensure you are aware of how much money you are making and whether you will reach the VAT threshold. If you reach the threshold and are not registered, you have 30 days to do this.
Example: VAT on a sports and leisure store
Your sports and leisure business was launched in March 2021 but you did not register for VAT as you didn’t expect it to reach the threshold in the first year of trading.
However, in September 2021 you introduce an exercise mat to the range and its sales take off. This and excellent sales at Christmas mean your total turnover is over £100,000 at the end of January 2022.
You have 30 days to register for VAT and must not wait until the end of the tax year.
If you are VAT registered, you have one month and 7 days after the end of the accounting period in which to submit your return. You must also make the payment by this date.
The government increases the VAT threshold most years, so you need to keep informed of any amendments.
How do I register for VAT?
VAT registration is easy in the UK and you can do it online. VAT registration in the UK is also free of charge. You have to register on the HMRC website.
You will need:
- your National Insurance number or Unique Taxpayer Reference (known as a UTR)
- your business bank account details
- records of the sale and purchase if you have bought the business
- details of any other businesses you’ve owned in the past two years
What VAT accounting scheme should I choose when registering?
There are various accounting schemes you can use when you register for VAT. The VAT status you select will depend on when you wish to submit your accounts and the goods you sell.
- Standard VAT accounting – used by the majority of businesses. You record VAT made on sales and how much you have paid for purchases, such as supplies, and submit a VAT return quarterly.
- Annual VAT accounting – if for any reason you cannot submit a return quarterly you can apply to do this annually, but you will still need to pay the VAT due each quarter.
- Flat rate accounting – for some small businesses paying a fixed amount is an option. You should discuss this with an accountant as it will only benefit you if you sell certain items. For example, if you are likely to sell lots of zero-rated goods this option may not be a good idea.
- Cash accounting – you only pay VAT when customers have paid you, which can help with cash flow, particularly for small businesses. The date of VAT payment is based on the actual date the customer paid, rather than the invoice date.
What are the benefits of registering for VAT?
Once you are registered for VAT you can claim back a VAT refund on goods you purchase for your business, from stationery to technology, raw materials and parts to make goods.
You will be issued with a VAT registration number which you can use on your website, invoices, letterheads and other paperwork and advertising material, which gives your company a professional image. This immediately tells people you have a certain income and makes you appear established.
Keeping up-to-date and accurate information and records on your business is essential so you know how much VAT to include on your return. It is advisable to keep digital records as these are likely to be more accurate. This will encourage you to be organised with your administrative systems, which can sometimes have less priority in a small business.
Can I be self-employed and VAT registered?
The rules for the self-employed are the same as for any other business. The self-employed VAT threshold is £85,000 and when you reach this level you have to register and will be issued with a self-employed VAT number. You then have to complete a self-employed VAT return just as any other business that exceeds the threshold does.
You can use a self-employed VAT calculator to work out how much VAT you should pay.
What happens if I submit or pay my return late?
If you submit your return or pay late you will be liable for a penalty charge. This will be calculated based on your turnover and how much you owe to the Inland Revenue.
The penalty could be up to 15% of the amount owed. A company with less than £150,000 will be given an amount of time to pay the outstanding amount before they are fined. However, it is not advisable to pay VAT late as this gives you a poor payment record.
Late VAT payments could have a severe financial impact on the business and cause a serious cash flow problem. For example, if you can´t pay staff because you are unable to make your VAT payments they may not attend work, in which case you may not have any staff to do the work.
It is advisable to keep funds for VAT payments in a separate account and not use them for other purposes. Whilst it can be tempting to buy a new smartphone or computer from the VAT account it’s better to wait until the business can afford it.
What are the penalties for not paying or paying too little VAT?
There are different penalties arising from not paying the correct VAT, which can be set by the Inland Revenue or the courts. It is always best to talk to the Inland Revenue to prevent them from taking court action.
The average penalty tends to be around £4,000, but this will vary depending on the circumstances.
You can be charged a penalty for failing to:
- register if your turnover exceeds £85,000
- pay the correct amount of VAT
- keep accurate records
- supply correct information
- charging a flat rate when you are not entitled to it
- issuing a VAT invoice if you are not registered
- refusing to allow a VAT inspector to enter your property
If you do not declare all your VAT on products or services that you have sold and been paid for, or claim more than you have been paid for the VAT, you will be charged interest. This could be from 3.75% which must be paid within 30 days or more interest will be charged. This interest will continue to be applied until you make the outstanding payment plus interest.
Note that from 2023, new requirements will be set by the UK government, which can be found here.
What if I pay too much VAT?
Paying too much VAT can be an unnecessary cost for your business so it’s best to avoid this. As an entrepreneur, you may not feel comfortable doing your own VAT returns so you should appoint an accountant to do them for you. There will be a charge, but this could save you money in the long run.
The most common reasons for paying too much VAT are:
- putting the wrong figures on the VAT return
- using the wrong percentage rate
- not using the correct accounting scheme
- poor bookkeeping
If you think you have paid too much VAT, you should contact the Inland Revenue to resolve the situation.
Sometimes paying too much VAT can be due to the Inland Revenue charging you the wrong rate, in which case you may be entitled to claim the interest on the amount. Again, you should contact the Inland Revenue to claim the repayment.
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What is the VAT registration threshold in the UK?
The VAT threshold 2022 is £85,000 before you have to become VAT registered and pay VAT.
What is the standard UK VAT rate?
The rate is currently 20% and applies to most goods and services.
Why should I keep VAT records?
You should keep records of both the VAT you pay on goods for your business and the VAT you charge so you can fill in your returns efficiently. This will save you time when you have to file the returns.
Do I need an accountant to do my VAT returns?
No. You can do your returns yourself. However, if you are not good with numbers and want to ensure your returns are accurate you should employ the services of an accountant.
Can I complete my VAT return online?
Yes, this is the easiest way to submit your return.
Do I have to register for VAT if I am self-employed?
VAT registration for self-employed is the same as for businesses. If your turnover exceeds the amount of £85,000 in any twelve months you must register for VAT, whether you are self-employed or not.
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