How much value in VAT?

The new workforce: some self-employed people will benefit from registering with Customs
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The Independent Online
Registering for value-added tax allows self-employed people to reclaim the VAT they pay on business costs. If your business costs are high, registering can be very worth while financially. In addition to the ability to offset allowable expenses against income for tax purposes, registering can boost savings on business expenditure from 40 to 49 per cent of a VAT-inclusive cost for higher-rate taxpayers and from 24 to 35 per cent for basic-rate taxpayers.

But a quid pro quo of making these VAT savings is that your own services might become less attractive. By registering for VAT, your services also become VAT-able. Customs & Excise will want to tax your sales at a rate of up to 17.5 per cent. Increasing your prices to meet this bill may not help your business.

That said, for many self-employed people supplying big companies, simply adding VAT to invoices to meet this bill should not be a problem - corporate customers that are themselves VAT-registered can reclaim the VAT paid to you.

You have to register for VAT if the value of what is called your taxable supplies exceeds pounds 47,000 in the previous 12 months (or if it is likely to exceed pounds 47,000 in the next 30 days).

In most cases, people will be making taxable supplies even if their business consists of some kind of service, such as acting as a consultant. This includes one-person businesses; the obligation is not confined to companies. Those whose turnover is below the pounds 47,000 limit have the choice of whether to register or not.

By registering for VAT you become something of a tax collector for Customs & Excise. The VAT you charge your customers does not increase your income.It has to be handed on - minus the VAT you are entitled to reclaim - to Customs & Excise.

If you buy plenty of things on which VAT is levied, it may be worth registering. If, for example, you have enormous phone bills, reclaiming the VAT will keep your costs down. It is also useful if you have a substantial capital outlay when you start your business - on things such as computers, fax machines and so on.

But if instead you spend a lot of money on books and newspapers or travelling on public transport, there will not be any VAT to reclaim because none is payable on these items.

The standard rate of VAT you can reclaim is 17.5 per cent of what you spend on goods and services (8 per cent in the case of gas and electricity bills, while some goods and services carry no VAT). If you do not reclaim the VAT you are able to include it when claiming allowable expenses on your income tax return.

For example, if a higher rate taxpayer who is not registered for VAT buys an item costing pounds 100 plus VAT for his business that is an allowable expense. He can, in effect, save pounds 47 (40 per cent of pounds 117.50) on the cost by offsetting it against business income. But if he is also registered for VAT his overall saving increases to pounds 57.50 or 49 per cent (the pounds 17.50 VAT plus 40 per cent of the before-VAT price). The equivalent saving for a basic rate taxpayer goes up from 24 per cent to 35 per cent.

Some goods and services are "exempt" from VAT, others are "zero-rated" - the rate of VAT payable is 0 per cent. Exempt and zero-rated may sound like the same thing but they are not. You cannot register if you are supplying only exempt goods and services - such as education, training and health care.

If you sell zero-rated goods there is a high chance that registering will be attractive. You do not have the potential downside of increasing your prices if you register, but you still get the advantage of being able to reclaim VAT on your own business costs. Zero-rated goods include books and children's clothes.

Adding VAT to your own invoices is not a problem if you are supplying businesses that are themselves VAT-registered. They simply deduct the VAT they have paid to you from the VAT that they have to hand over to Customs & Excise. In other words, it does not increase the cost to them of doing business with you.

But if you are supplying the general public, or other businesses that are not VAT-registered, adding VAT will increase the cost of using you or buying from you. And that is a big consideration if you are thinking about registering voluntarily. In addition, registering means the chore of submitting VAT returns. Consider whether your time could be more profitably used by going out and getting more contracts and selling your goods and services.

Lastly, registering for VAT need not be a lifetime commitment. If you find it all too much you can de-register, provided your turnover is below a certain limit - currently pounds 45,000. But if you do de-register, you will have to pay back the reclaimed VAT on items that are still used in the business.

For information on VAT and details on how to register, look under Customs & Excise in your local phone book. A new booklet, Starting Your Own Business, (reference number CWL1), which deals with the basics of income tax, national insurance contributions and VAT, is available from Customs & Excise or the Inland Revenue.

Would you like to be a business?

A question that arises for some self-employed people is this: are there advantages in becoming a limited company? There is no straightforward answer.

A limited company separates your business assets - leaving your personal assets beyond the reach of creditors should the business ever get into trouble (though this will not be the case if you have made a personal guarantee to your bank or other creditors).

Instead of being self-employed, you would be a director-employee of the company and pay yourself a salary.

This can be useful for higher-rate taxpayers because profits can be left in the company rather than paid as salary, making them likely to be taxed at a lower rate, depending on the company's turnover.

Another possible advantage is that you can channel more money into your pension through a company.

But these considerations have to be weighed against the costs of setting up a company, having accounts audited, and dealing with more paperwork.

Before forking out for professional advice, get an idea of the complex issues involved. The Lloyds Bank Small Business Guide, published by Penguin (pounds 16), contains an excellent summary of the pros and cons of being a sole trader, partnership or limited company.