Should I register my business for VAT?

This is an important question for many small businesses as it can really make a difference to how you operate. Firstly though, it’s important to note the requirements for VAT registration. The HMRC website states:

“You must register if either:

• your total taxable turnover for the last 12 months goes over £90,000 (the VAT threshold)

• you expect your taxable turnover to go over £90,000 in the next 30 days”

So, if your business turnover is going to pass the VAT threshold then you have no option but to register. However, if your turnover is less than £90,000 in a year there still may be some advantages for registering for VAT.

At this point it’s important to remember that if you register for VAT then your business is collecting VAT on behalf of HMRC, the money is never yours, so shouldn’t be treated as such. We always recommend an additional bank account or “pot” (accounts such as Monzo allow multiple pots in one account for things such as this) where you can put the collected VAT each day, week, month so that you’re not hit with a surprise VAT bill.

If you register for VAT then you need to collect VAT on the sales of relevant products or services, this is known as “output tax” or “output VAT”. However, you can reclaim the VAT on products and services your business has bought, this is known as “input tax” or “input VAT”. If you’re not VAT registered, you’ll still have to pay VAT on these products and services that you have bought, but you cannot claim this VAT back.

One of the main disadvantages of registering for VAT is that if your business is a consumer facing business then it’s likely you’ll have to put your prices up. To go back to the coffee shop example from a previous post, imagine your business is not registered for VAT and you charge £3.00 for a coffee (we’re simplifying a little) and sell on average 2,400 per month. That gives you a yearly turnover of £86,400, just under the VAT threshold. All your costs, direct costs such as coffee beans, milk, barista wages, etc and indirect costs such as business rates, electricity, cleaning products, etc. come out of this and hopefully there’s some profit at the end.

Imagine now that your business grows and you sell an average of 2,600 coffees per month. This gives a turnover of £93,600, which is above the VAT threshold and therefore you must register your business for VAT. So now VAT has to be deducted and in this case that would be £15,600, which would leave you with £78,000 left, but then all the direct and indirect costs mentioned above have to come still. In this scenario, even with selling more coffee your business is worse off as VAT now has to be collected. That is why you’d then have to put your prices up to handle this. In order to cover the VAT and not be worse off you’d need to put the price of a coffee up to approximately £3.35, which is quite an increase and may not go down well with your customers.

Please note that we just used coffee in the above example (and 2,600 coffees per month is quite an inflated figure) but most coffee shops will also have cakes, pastries, sandwiches, soft drinks, etc. some of which will be VAT rated and some not. We stuck solely with one product to keep the calculation simple.

A similar situation could occur for any business which sells to consumers and are thinking about registering for VAT. It’s important to think about this from the outset of your business so that you don’t have to make difficult decisions further down the line, especially at that tricky time when your business crosses the VAT threshold.

It’s a slightly different situation if your business sells to other businesses and not directly to consumers, although you may still have to put your prices up when you register. Here there are a few more advantages to being VAT registered, even if you’re under the threshold. One advantage is that your customers will then be able to claim back the VAT they pay on the goods or services bought from your business and this may make them look upon your business more favourably. Perception plays a part too as non-registered businesses can seem too small to some other businesses so they may not be keen to do business with you. Being VAT-registered may improve this perception.

Vat registration also means that it’s essential to keep accurate records. While this may not seem like an advantage, it really is. Accurate record keeping will help you learn so much more about your business and also help you keep on top of vital things such as cash flow, VAT liability and many other aspects of your businesses financial health.

There’s also the possibility that you may be able to claim VAT back from the last 4 years from registration. To do this, the items must still be in use, your business will need to have existed for 4 years and you must be able to provide VAT invoices and financial records for those years. Depending on what type of business you have, this could lead to a significant return.

There’s so much more to VAT and it varies from sector to sector so it’s always worth spending time properly researching whether it is the right move for you and your business and of course, we’re always on hand to advise.