Going Independent: The 'fiscal theme park' of VAT

In our continuing series on the tax system, what is value added tax, who needs to register for it and how to benefit from it

Unless we work in the world of finance, most of us, happily, won't give much thought to VAT. To the consumer it is a largely invisible tax, since retail prices in the UK are usually quoted inclusive of VAT. So, while VAT is a tax paid by the final consumer (generally private individuals), it is the UK's businesses which fill the role of unpaid tax collectors for the Government.

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Unless we work in the world of finance, most of us, happily, won't give much thought to VAT. To the consumer it is a largely invisible tax, since retail prices in the UK are usually quoted inclusive of VAT. So, while VAT is a tax paid by the final consumer (generally private individuals), it is the UK's businesses which fill the role of unpaid tax collectors for the Government.

This means that those starting up in business for the first time are faced with a whole new world of tax with quite different rules and regulations from such familiar friends as income tax. You may have heard that VAT can be absurd or fiendishly complicated, a fact beautifully summed up by Lord Justice Sedley in a recent court case: "Beyond the everyday world... lies the world of VAT, a kind of fiscal theme park in which factual and legal realities are suspended or inverted."

While this is true for multinationals, the good news is that, for most people starting in business, things are not quite that drastic. Here are the main issues to consider:

Are the goods or services you supply liable to VAT in the UK?

Does this mean you have to register for VAT – or should you register voluntarily?

Once you are registered, what administrative burdens does this entail?

VAT liability

Assuming you are setting up in business in the UK and supplying goods or services to UK customers, your income will most likely be subject to VAT (commonly known as "taxable income"). There are exceptions to this – principally for those involved in financial services. Other exempt sectors include certain dealings in property, health and education services, and betting and gaming. If you are involved in one of the exempt sectors, you will need to seek specialist advice.

The standard rate of VAT in the UK is 17.5 per cent. Thus, if the value of your supply is £100, then you will need to charge an additional £17.50 in VAT if you are VAT registered. There are two other VAT rates – first, a rate of 5 per cent which applies to a few specific supplies (e.g. fuel and power), and second a "zero rate". This is not to be confused with exemption, since zero-rated supplies qualify as "taxable income". The main zero-rated supplies likely to affect readers are food, books and journals, exported goods and (certain) services; so if your customers are located overseas, you may not need to charge them UK VAT.

Once you have established the correct VAT liability of your proposed income, you will need to consider whether this means you should register for VAT.

VAT registration

You must register for VAT if the value of your taxable income has exceeded £54,000 in the previous 12 months. You will also have to register for VAT if, at any time, you believe your taxable income will exceed that amount in the next 30 days.

Strange as it may seem, however, many new businesses choose to register for VAT voluntarily. This is generally done so that the VAT that is incurred on purchases from your suppliers can be reclaimed, or in order to add to the credibility of your embryonic business. If your own customers are businesses (rather than private individuals), they will usually be able to reclaim the VAT that you will have to charge them once you are registered, so this can serve to reduce your own costs without increasing the effective level of your charges to your customers.

Administration

The biggest downside to registering for VAT, particularly for small businesses and start-ups, is the red tape and administration. Registration is completed by submitting a form ("VAT 1", available from HM Customs & Excise at your local VAT office); once you are registered, there are a number of requirements. For example, you will need to raise and issue tax invoices, containing specified information, to your business customers. You will also need to keep accounts of income and expenditure and prepare and submit VAT returns, generally on a quarterly basis. If the VAT payable on your income exceeds the VAT reclaimable, the net payment must accompany the return when it is submitted to HM Customs & Excise. If VAT on purchases exceeds VAT on income, Customs will duly send you a refund of the difference.

What VAT can you reclaim?

VAT can be reclaimed on most purchases, provided these purchases are to be used for your business. For example, if you buy a computer for £1,500, this includes £223.40 of VAT that can be reclaimed, therefore the net cost is only £1,276.60. It is also worth knowing that some of the VAT incurred before you register can be reclaimed after registration.

Reducing the burden – annual and cash accounting

If you register for VAT, there are ways to minimise the administration involved. For example, you could apply to join the Cash Accounting or Annual Accounting schemes, both open to businesses with a turnover of less than £600,000 a year.

Cash Accounting means you pay or reclaim VAT on the basis of when you make or receive payments. This can be advantageous, because in normal circumstances you would need to account for VAT on the basis of invoices issued and received. This could mean you raising an invoice and having to pay the VAT to Customs some time before you are paid yourself – not helpful for cash flow.

Annual Accounting means you submit a single annual VAT return. You also need to make periodic payments based on your estimated VAT liability.

Patrick Walker is National Head of Indirect Taxes at PricewaterhouseCoopers

Information

HM Customs & Excise have a network of local VAT Offices around the country. Speak to your nearest Business Advice Centre listed under "Government Offices" in your phone directory, or visit their informative website at www.hmce.gov.uk

f you need information on international VAT, try www.globalvatonline.com This contains information on VAT in more than 70 countries, including weblinks for the relevant VAT authorities, for an annual subscription of US$500 (£350).