VAT Definition

What is VAT?

The VAT definition in the UK is that it’s an incremental tax based on the increase in the value of a product or service. In some countries, it’s referred to as a goods and service tax or GST, while other countries don’t have any form of VAT at all. VAT was introduced into the UK in 1973 as a replacement for the earlier Purchase Tax, which was applied to the wholesale rather than the retail price of goods and services.

It is currently the third-largest source of revenue for the government. VAT is added to the cost of most goods and services provided by businesses in the UK. Certain goods and services imported from outside the EU are also subject to VAT, as well as the majority of imports from within the European Union.

In the UK, VAT is a tax on consumer spending, and businesses are required to register for VAT when they go above a certain taxable income threshold.

The rate of VAT is currently set at 20%, although some goods are subject to a reduced rate of 5% (such as household fuel). Other goods that are regarded as essentials (such as children’s clothing) are VAT-free. As the UK is (currently) part of the EU, the standard (non-reduced) rate of VAT cannot be any lower than 15%. Once the UK leaves the EU, it will have the right to set its own VAT rate, although the likelihood of the current rate changing is remote.

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An ‘indirect tax’

VAT is known as an ‘indirect tax’. That means it’s paid to the government by the seller of the goods or services and not the consumer, although the cost of the goods and services to the consumer is directly affected by the inclusion of VAT.

Input VAT definition

Input VAT or input tax as it’s also referred to is the VAT charged on the purchase price of goods and services you buy from another supplier.

Output VAT definition

If you are VAT-registered, then output VAT or output tax is the charge on the sale of goods or services from your business. This is charged to both retail customers and business customers at a rate of 20%.

The difference between the two (input and output VAT) is the amount you then pay to HMRC. If your input tax exceeds your output tax, then you can claim back that money from the Customs and Excise department.

Who has to register for VAT?

Any business that provides what is termed as ‘taxable’ goods and services (for example, those that do not fall into the VAT-exempt bracket such as food or children’s clothes) and whose taxable turnover is greater than the threshold set must register for VAT. As of 2018, that threshold is £85,000 but may increase in the 2019 budget statement. The UK’s VAT threshold is the highest in the world, meaning that SMEs (including small franchises) do not have to carry the burden of extra taxation until their taxable turnover exceeds this amount. For new start-ups and franchises that are only just getting off the ground, this is an important benefit as it gives them a chance to establish their business before they have to start paying the additional level of tax. It is possible for businesses with a lower turnover to register for VAT voluntarily.

The Flat Rate Scheme

This is a scheme run by HMRC that allows businesses with an annual turnover of less than £15,000 to pay a fixed percentage of their turnover to HMRC every three months. It minimises the amount of ‘red tape’ that small businesses have to go through when compared to normal VAT registration, and also allows them to keep a certain amount of the VAT they charge their customers.

Who doesn’t register?

If you sell exempt goods or supplies, then you cannot register for VAT or reclaim any VAT that you may have incurred on purchases for your business. If you sell a mix of taxable and exempt goods then you can only reclaim the VAT you incur on purchases that are directly related to onward taxable supplies.

I run a food franchise. Do I register for VAT?

If you supply food and drink for consumption on the premises such as at a restaurant or café or provide hot takeaway food and drinks, then the standard rate of VAT is applicable, which means you must register for VAT once you go over the threshold. If you run an exempt franchise, such as a sports coaching franchise, then you’re exempt from VAT (but that also means you cannot claim the VAT back on any purchases you make for your business).

How to register for VAT

If your taxable turnover exceeds £85,000, you buy in over £85,000 worth of supplies, or you decide to register for VAT voluntarily, you can do so online. By doing this, you can create an online VAT account (also known as a Government Gateway account). This allows you to submit your VAT returns to HMRC as and when they are due. When you sign up, you’ll be given your VAT number by HMRC. This needs to appear on things such as invoices and documents such as headed notepaper, online and offline advertising, etc. You should receive a VAT registration certificate within 30 working days of registering (be aware, though, it can take longer).

If you want to apply for a registration exemption or are registering different parts of your business under separate VAT numbers, then you must apply by post to register using a VAT1 form.

You can ask an accountant to deal with your VAT returns on your behalf, or do it yourself.

What happens if I don’t register?

If you don’t register for VAT and your taxable turnover goes above the threshold, then you could be subject to an investigation and hefty fines. If you’re late paying your VAT returns then again, there could be penalties incurred (£100 plus a percentage of the VAT amount due). HMRC can overturn penalties for late payment if you offer a ‘reasonable excuse’ such as serious illness or technology problems, but it is at the discretion of the Revenue Service.

How do I charge my customers VAT?

VAT is usually added onto the invoice. Generally, if you are invoicing a customer for services or goods and are applying VAT, you will first quote the sub-total excluding VAT, then list the amount of VAT being charged clearly (usually at 20%), and then the final total combining the sub-total and the amount of VAT charged. This is so that if a customer is VAT-registered, then they can show exactly how much VAT they’ve paid if they want to claim the amount back.

I’m already VAT registered. Can I transfer my registration to my new franchise?

It is possible to transfer your VAT registration from one business to another, by applying for a VAT registration transfer online or by post using a VAT68 form. It usually takes around three weeks for a transfer to go through, although it can take longer if there are any queries.

Franchisees – who is responsible for registering?

Generally, it will be down to the franchisee to register for VAT, and not the franchise provider. The turnover of the business will be down to you, the franchisee. And you will be seen as the sole beneficiary of the business (unless there are royalty fees to pay). As a result, you are responsible for the payment of VAT once you go over the threshold.

Can I claim back the VAT on my franchise fees?

If you are already registered for VAT when you buy a franchise that has a VAT charge on the fees, then you should be able to claim the VAT back. You will need to make sure that you include it in your next return. If you are not registered, then you cannot claim the VAT back. You may be able to if you subsequently register afterwards, but it could mean a delay in any monies paid to you by the Revenue Service.

Conclusion

VAT is possibly one of the most complex taxation systems in operation, and can often be seen as the bane of any small business. You do not, however, have to register to pay VAT until your taxable earnings are more than £85,000. However, you can voluntarily register for VAT even if you earn less than that under HMRC’s Flat Rate Scheme. Non-payment of VAT if you earn over £85,000, or late payments if you are registered, can result in hefty fines, although HMRC does have the ability to waive penalty charges for late payment if there are exceptional circumstances.

The standard rate of VAT in the UK is 20%, with two other rates of 5% and 0% for certain categories of goods and services. If you buy into a franchise then you will be responsible for registering your business for VAT – it is not the responsibility of the franchise provider to register on your behalf. If you are already registered, then you can transfer that registration over to any new business you start up, including a franchise.

Because of the complexities of VAT, our top tip is to talk to an accountant rather than trying to tackle VAT registration yourself.