VAT ACCOUNTING SIMPLIFICATIONS
15th June 2022
Once a business is registered for VAT, there are a number of accounting simplifications that can help ease the burden of VAT accounting.
Below we look at some of the options available:
Before discussing simplifications, it is, perhaps, relevant to cover how the business accounts for VAT. A business that can reclaim all the VAT it incurs on its costs should post all transactions net of VAT and post the VAT element to a VAT account. The accounts will then be totally VAT exclusive.
Problems do arise where a business cannot reclaim all of its VAT; perhaps it is making VAT exempt transactions like rents, or finance transactions, or there is an input tax block, such as not being able to claim back VAT on a car. The VAT is then to be included as part of the cost of the item purchased and the accounts will have a VAT element in it.
The default position for VAT accounting is that it is to be paid to HMRC (on the VAT returns) when an invoice is raised by the business. This gives the problem of accounting for the VAT on sales before the sales invoice has been paid by the customer. The VAT on purchases can, however, be reclaimed as soon as an invoice is received, even before the supplier is paid.
Most small businesses find that they pay their suppliers before their customers pay them. Also, the VAT on sales is usually more than the VAT on purchases. This means the business will have negative cash flow for VAT. This problem has been recognised by HMRC and they will allow small business to account for VAT on a cash basis. A business can use cash accounting where they expect their taxable sales (that is sales subject to VAT at the zero, reduced or standard rate) to be £1.35 million or less in the next 12 months. There is no need to apply to use the scheme, but it can only be used from the start of a VAT period.
When using cash accounting, you only pay VAT on your sales when customers pay the business. VAT can only be reclaimed on purchases when the suppliers are paid.
The scheme cannot be used where the Flat Rate scheme is used, where the business is not up to date with its VAT returns or payments or the business has committed a VAT offence in the past 12 months.
There are a number of restrictions on the use of the scheme. It cannot be used where invoices are raised in advance, where payment is not due for six months or longer. Cash accounting also cannot be used for lease, hire purchase or credit transactions, nor for importing goods into Northern Ireland from the EU or when moving goods from a customs warehouse.
A business can leave the scheme whenever it wishes, but it must leave the scheme when their taxable sales exceed £1.6 million. HMRC does not need to be informed. Any VAT outstanding on sales made needs to be accounted for to HMRC, when paid, over the next six months.
VAT ACCOUNTING PERIODS
VAT is normally accounted for using three monthly VAT returns. A business can, however, use monthly returns where it normally receives VAT repayments. This can be used by a business that makes zero-rated sales, and the VAT on its expenses exceeds any VAT to be accounted for on its sales. Also, if the business is incurring a lot of expenses in creating its business (for example, constructing a factory), it will incur more VAT on its expenses than is to be accounted for on its sales. A business in a repayment situation can apply to HMRC for monthly returns. Contact can be made with HMRC on 0300 200 3700.
Businesses with a turnover of £1.36 million or less can apply to account for VAT on an annual basis. VAT instalments will be paid during the year, with a balancing payment (or refund) at the year-end. An application cannot be made for annual accounting if the business left the scheme in the last 12 months or the business is part of a VAT registered division or a VAT group. Annual accounting also cannot be used if the business is not up to date with its VAT returns or payments or the business is insolvent.
An application to use annual accounting can be made when the business registers for VAT or by completing form VAT600AA (or VAT600 AA/FRS if the Flat Rate scheme is also being applied for). The form is to be sent to:
HM Revenue and Customs
A business can leave the scheme at any time and must leave it when their turnover exceeds £1.6 million at the end of the annual accounting year. HMRC needs to be informed that the business is leaving the scheme.
The business needs to make payments on account. The payment will either be 10% of the estimated VAT bill when monthly payments are made or 25% when quarterly payments are due. This is based on previous VAT returns (or estimated if it is a newly VAT registered business). HMRC will write explaining when instalments are due and how much they are. The final payment is due to be paid two months after the end of the annual accounting period.
Whilst this scheme provides a significant reduction in administration, many businesses prefer the discipline of making quarterly returns.
VAT FLAT RATE SCHEME
The amount of VAT a business has to pay is the difference between the VAT charged to customers and the reclaimed on its expenditure. An alternative method is for the business to pay a fixed flat rate of VAT to HMRC. This amount may differ from the true VAT liability. A business using the scheme does not need to account for any extra VAT on its sales, but it cannot reclaim VAT on expenditure, other than the VAT on capital expenditure costing over £2000.
To join the VAT Flat Rate Scheme, the taxable turnover of the business must be less than £150,000 (excluding VAT). The scheme cannot be used if the business left the scheme in the past 12 months, or where a VAT offence has been committed in the past year, or if the business is using a VAT margin or capital goods scheme. The scheme is not available for businesses that are in a VAT group, a VAT division or is closely associated with another business.
An application to join the scheme is to be made on VAT600 FRS and it can either be e-mailed to HMRC to firstname.lastname@example.org or posted to:
HM Revenue and Customs
VAT600 AA/FRS is to be used if the Annual Accounting scheme is also being applied for.
A business can leave the scheme at any time and must inform HMRC it is leaving the scheme. The business must leave the scheme if its turnover exceeds £230,000 in the past 12 months, or it is expected that its income will exceed £230,000 in the next month or in the next 12 months.
The key to whether this scheme is suitable is the VAT flat rate that is to be applied. There are numerous rates that can be applied depending on the business type. These range from 4.5% to 14.5% and are shown in Public Notice 733. A further discount of 1% is applied in the first year as a VAT registered business.
The amount of VAT to be accounted for is the flat rate applied to the VAT inclusive sales figure. Thus, if a business charges a customer £5000 net of VAT, it will add VAT at 20%, £1000, to the charge (and raise an invoice showing this VAT). The total charge to the customer will be £6000. If the flat rate that applies to the business is 8%, it will account for VAT to HMRC of £480. This is clearly less than the VAT charged to the customer (who can reclaim the VAT charged of £1000). The business using the flat rate scheme, however, cannot reclaim any VAT on its expenditure other than VAT on capital items costing more than £2000.
Using the flat rate scheme is a simplification, as it is not necessary to account for VAT on sales or reclaim VAT on expenditure. The business needs to make sure it is using the correct VAT flat rate and that this is not disadvantageous to the business.