Do Small Businesses Pay VAT?

VAT is a tricky area of business finances. Find out what VAT means for you and your small business, who should pay it, and why.

Hannah Dawson

Value-Added Tax (VAT) is a crucial factor in your business's finances - it is not just a bill your business might have to pay but also something you might have to charge your customers. This can result in your business having to put its prices up or reduce its profit margin. All these things can impact the ongoing business finances - which is why forecasting and planning are so important. This short guide looks at what VAT is, what businesses need to be registered, how to calculate it, and the VAT Flat Rate Scheme.

What Is VAT?

Value-Added Tax, VAT for short, is a consumption tax levied by the government and assessed on the value of a product or service from production through to its sale. VAT is payable on sales of goods or services and is assessed incrementally, levied on the price of a product or service at every stage. This amount is determined by the cost of the product or service minus any materials used that have already been taxed. The standard rate of VAT in the United Kingdom is 20%.

The consumer ultimately is the one paying VAT on a product or service. They pay VAT to the seller who then pays it to the government in their VAT returns. VAT is charged equally on every purchase, it is not income-based.

There are several advantages to VAT - it provides the government with revenues without charging wealthy taxpayers more. It represents a very simple and effective form of tax payments. However, it can be argued that VAT places a burden on people with low income. For businesses, VAT presents a considerable bureaucratic effort.

Does My Business Have To Be VAT Registered?

Legally, any business turning over GPB 85k is obliged to register for VAT (for more information, click here). However, even if your business is not obliged to register, there is several advantages as a VAT registered business:

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  • VAT registered businesses can reclaim (part of) the VAT paid if most or all of your customers are VAT-registered businesses.
  • Once you are registered, your business can reclaim VAT costs. If, for example, the start-up costs included VAT payments, you can claim those back which can significantly increase your cash flow.
  • Being registered for VAT makes your small business look professional to competitors and potential customers.
  • If you are working with other businesses and applying for tenders, it may be beneficial for your application if you are VAT registered.

There are also several disadvantages to registering your business for VAT.

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  • If your business decides to register for VAT, the VAT obligations will get passed on to your clients which automatically increases your prices. This can give you a competitive disadvantage when trying to attract customers.
  • Registering means understanding the VAT rules, which can be immensely complicated in some sectors.
  • Once you are registered, you have to submit VAT returns to HMRC four times per year which causes a significant bureaucratic workload. Filing your VAT late can result in fines.
  • Some sectors, such as healthcare, are VAT-exempt. If you are dealing with customers in those sectors, they will not be able to claim back VAT after you have charged them.
  • As the VAT scheme can be quite complex, you may have to hire an external adviser to help you with your VAT return.

What Is The VAT Flat Rate Scheme?

With the VAT flat rate scheme, businesses pay a fixed percentage of their annual turnover as VAT. The flat rate your business has to pay depends on the type of business you run. This is likely to be about the same amount the business in question would pay anyway, but without the significant amounts of paperwork. If there is a difference between this fixed percentage and the amount paid by customers, the business gets to keep it. However, with this scheme, businesses typically cannot reclaim VAT. To join this scheme, your company must have an annual turnover of less than GPB 150,000 (excl. VAT) and be registered for VAT.

How Do I Calculate how much VAT I have to pay?

Calculating VAT can be complicated, especially if you’d rather be running your business than working out finances. Luckily, these days there are plenty of tools and software that can take the hassle out of it. Using an old-school spreadsheet comes with several disadvantages - you need to manually update it, it is more prone to error, and formulas can break. Using software, however, can minimize errors and time required to calculate VAT for your business. Get in touch with us at Futrli to see how we can help.

What Is Reduced Rate VAT?

As mentioned above, the standard rate of VAT in the United Kingdom is 20%. Anything classified as a luxury product falls into this category too. Hence food items, such as ice cream or confectionary fall into this bracket. There is a reduced VAT rate that applies to specific items, such as power or domestic fuel. Specific categories of products even fall under the so-called zero rate. This includes any items or products the government defines as necessary, for example, food products, newspapers, and books. A zero-rate is not to be confused with VAT-exempt - the former means goods on which the Government charges VAT with the rate set at zero, while the latter refers to goods on which no VAT is paid. However, these are still included in your VAT return.

Small Business VAT FAQs

  • Do I have to charge VAT if I am self-employed?

Not all those that are self-employed are required to register for VAT. However, you have to register for VAT if your VAT taxable turnover goes over  GPB 85,000 (the ‘threshold’).

  • Do charities pay VAT?

Yes, charities do pay VAT on standard-rated goods they purchase from businesses registered for VAT. They do, however, pay the reduced rate or the zero rate on some goods.

  • Do sole traders pay VAT?

Again, some, but not all, sole traders have to register for VAT. If their turnover exceeds GPB 85,000 per annum, they are obliged to register.

  • How much VAT does a business pay?

The standard rate of VAT in the United Kingdom is 20%. There is a reduced VAT rate of 5% that applies to specific items, such as power or domestic fuel. Specific categories of products even fall under the so-called zero rate.

  • Do I have to pay VAT if I'm self-employed?

Self-employed people also pay VAT on the majority of goods and services they purchase.


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