In broad terms, and subject to certain exceptions, a business will be required to register to charge and pay VAT once annual sales reach a pre-set annual threshold, which is currently £85,000. This threshold is determined by total sales and is not the same as total profits (which is generally sales minus expenses).
However, a business can register for VAT even if its turnover (total sales) is below the threshold and it may actually save tax by doing so, particularly if its main clients or customers are organisations that can reclaim VAT themselves.
Bill is a non-VAT registered painter and decorator. He is a basic rate (20%) taxpayer. He buys a new ladder to use in his business, which costs him £100 plus VAT, so he pays a total of £120 (£100 plus VAT at 20%. Bill will set £120 as a cost against his business profits. As he is a basic rate taxpayer, he will save tax of £24 (£120 x 20%), so the ladder actually costs Bill £96. However, if he is registered for VAT, the £20 VAT paid on the item (the input tax) can be reclaimed and £100 is set against business profits for income tax. The tax reduction is therefore £20 (£100 x 20%) and the ladder costs £80 – saving £16 by being registered for VAT.
VAT-registered businesses supplying goods and services to private individuals often feel dis-advantaged compared to their non-registered counterparts because they have to charge an additional 20% on every bill issued.
A trader who does not want to have to register for VAT, may be able to stay below the annual VAT registration threshold by supplying labour-only services and getting customers to buy any goods needed themselves.
Deciding whether to register for VAT voluntarily before the registration threshold is reached is a big decision that can have lasting implications for the financial health of the business. Positive reasons supporting voluntary registration include:
- Reclaiming VAT – although a registered business will have to charge VAT on goods and services (known as charging ‘output tax’), it will also be able to reclaim VAT that it is charged by other businesses (known as ‘input tax’). Where input tax exceeds output tax in a given period, the business will generally be able to reclaim the difference from HMRC.
- Marketplace perceptions – some businesses choose to register for VAT in order to appear larger than they are. Customers are likely to be aware of the £85,000 registration threshold – and where a business is not registered, its customers will know that the business turnover is lower than this. A business may therefore consider registration as a way of increasing its standing amongst competitors, and in the eyes of clients.