"Is it beneficial for my business to become VAT registered?"
As with a lot of things in business, it depends on your circumstances...
Some business owners voluntarily register even though they're under the £85,000 sales threshold.
If most of your customers are VAT registered - it usually is beneficial to register for VAT.
If most of your customers are not VAT registered (i.e. they're small businesses and/or individuals) - it usually won't be worth becoming VAT registered.
If you go over the VAT threshold you probably won't have a choice - the VAT threshold currently stands at £85,000 and so if you earn more than that in any rolling twelve month period you must register for VAT a month later - you therefore need to check your sales figure every month to see if you've gone over the threshold.
For example, at the end of June 2001, I add up all my invoices over the past twelve months from July 2000 to June 2001 and find that I have made a total of £90,000 in sales. I conclude that I've gone over the £85,000 threshold and so I must then register the business for VAT a month later from 1st August 2001.
Examples are given below showing different VAT registration scenarios.
Let's say that your customer is willing to pay you £120 for your product.
Let's also say that you have paid out £60 in expenses - which is made up of £50 net and £10 in VAT. The 'net' amount is the amount before VAT of 20% is added. A VATable £60 expense would therefore be £50 net + 10 VAT (i.e. '£50 net' x '20% VAT Rate')
If your business is not VAT registered: (*)
- Sale = £120
- Expenses = £60 (**)
- Profit = £120 sale - £60 expenses = £60
It's very simple when you're not VAT registered, you receive £120 from your customer and you pay £60 out in expenses, leaving you with £60 in profit.
(*) There is no VAT on your sale and so it's irrelevant if your customer is VAT registered as they can't claim VAT back.
(**) VAT on expenses is ignored because you're not VAT registered and so you can't claim VAT back.
"Your customer doesn't pay a higher price which is good but you can't claim back any VAT on your expenses. If your customers cannot claim back VAT it would definitely be worth remaining under the VAT threshold. Some shops close for business because it just isn't worth them trading just above the VAT threshold - they'd be working for no reward and may even lose money".
If I am VAT registered but my customer isn't:
- Sale = £100 net + £20 VAT (20% net) = £120
- Expenses = £50 net + £10 VAT (20% net) = £60
- VAT Due to HMRC = £20 VAT on sale - £10 VAT on expenses = £10
- Profit = £120 Sale - £60 Expenses - £10 VAT Due to HMRC = £50
You receive £120 from your customer and you pay £60 out as expenses, leaving you with £60 in profit.
However, you now have to pay £10 in VAT to HMRC. This is the £20 in VAT on your sale minus the £10 in VAT on your expenses = £10 in total.
Your profit figure would therefore be £50 which is £10 less than if you weren't VAT registered.
"You'd have to pay 1/6th of all of your sales to HMRC in VAT but you could claim back the VAT on your expenses. This makes a huge difference if you don't have many VATable expenses - it would therefore definitely be worth trying to stay under the VAT threshold for as long as possible. If you wanted to grow the business beyond the £85,000 threshold though, you'd have to go over the limit at some point."
If my customer and I are both VAT registered:
My customer can now claim back VAT on their expenses and so I can now charge £120 Net + £24 VAT = £144 Total. They would pay you £144, then claim back £24 on their VAT Return and so it would cost them £120 in total.
- Sale = £120 net + £24 VAT (20% net) = £144
- Expenses = £50 net + £10 VAT (20% net) = £60
- VAT Due to HMRC = £24 VAT on sale - £10 VAT on expenses = £14
- Profit = £144 sale - £60 expenses - £14 VAT Due to HMRC = £70
You receive £144 from your customer and you pay £60 out as expenses, leaving you with £84 in profit.
However, you now have to pay £14 in VAT to HMRC. This is the £24 in VAT on your sale minus the £10 in VAT on your expenses = £14 in total.
Your profit figure would therefore be £70 which is £10 more than if you weren't VAT registered.
"If all of your customers are VAT registered, it is worth becoming VAT registered as it doesn't cost your customers anything but you can claim back VAT on your expenses. However, if you're VATable expenses are low (e.g. you're a consultant) you might want to consider whether it's worth the administrative burden of submitting a VAT Return to HMRC every three months."
Other Things To Consider
Making tax digital - any business over the £85,000 VAT threshold will need to submit additional information to HMRC every three months, click here for more information.
More complication - as you can see in 'example 1', not being VAT registered is so much simpler and you don't need to work out if your expenses do or do not contain VAT.
Cashflow - you will receive more into your bank account because of the VAT on your sales but then you have to pay it to HMRC on a three month basis. This is effectively an interest free loan for a few months.
Administrative burden - you will need to submit VAT returns to HMRC every three months.
VAT isn't backdated - VAT is only payable from the date you register and so isn't backdated to include sales from a previous period where the business was under the VAT threshold.
Zero rated - some businesses don't have to include VAT on their sales but can claim for VAT on their expenses. This would mean that HMRC would pay you a refund! Builders working on new build houses would fall into this category.
Exempt - some businesses don't have to include VAT on their sales but they can't claim for any expenses either as they fall outside the scope of VAT altogether. Businesses providing insurance or education would fall into this category.
To find out if your business activities are zero rated or exempt click here.