Choosing the right scheme for your business
If you are thinking about registering for VAT but don’t know whether to choose between Standard VAT Accounting, Flat Rate VAT or the Cash Accounting, then we have put together this easy-to-understand guide to help explain the key differences, and the main pros and cons. For more information you can also see our Guide to the Flat Rate VAT Scheme.
Standard VAT Accounting
One of the main advantages that most businesses gain from becoming VAT registered is being able to claim back the cost of VAT paid on any purchases for goods or services made through the business.
You will need to complete a VAT return every quarter and if you are using standard VAT accounting then your return will need to include:
- Output tax – Output tax is term for the VAT that you have charged your clients or customers. This is the percentage (usually 20 per cent) that you have added onto the prices of your goods and services. Even if they have been invoiced but you are yet to collect payment, you must still include the VAT on your return for that quarter.
- Input tax – Input tax is the what you yourself have been charged in VAT, the amount that has been added on to goods or services you have bought from your suppliers during that quarter. As with output tax, you must include anything billed during that period, even if you haven’t yet paid for it.
This means you have to pay and reclaim VAT according to the dates your invoices have been raised, not the dates they have been paid or collected.
Key points to remember about VAT:
You are not obligated to register for VAT until your revenue reaches £79,000 per annum, or if you expect it to within the next 12 months.
You can volunteer to register even if you haven’t reached the revenue threshold. There can be advantages to this, such as being able to pitch for work with companies who only deal with supplier which are VAT registered, or being able to reclaim VAT if you buy a lot of stock on which VAT is charged.
The standard VAT rate is 20 per cent, although some goods and services may be exempt from VAT or charge a reduced rate.
Standard VAT Accounting – the advantages
Being able to reclaim VAT charged on goods or services purchased can be a great boost for cashflow. Especially if you are able to claim the VAT back before you’ve even paid for the goods – this is what you would do if you have been invoiced for an item in one quarter, even if you won’t actually pay for it until the next quarter.
Standard VAT Accounting – the disadvantages
Depending on your payment terms and the payment habits of your customers, VAT can also be something of a cashflow drain if you are required to pay the VAT for invoices that you are yet to receive in full from your client.
An introduction to the most commonly used VAT schemes:
The Flat Rate VAT Scheme
Eligible companies registered for VAT can register for the Flat Rate Scheme, an initiative aimed to make your VAT return simpler and help small businesses benefit from some extra revenue through VAT.
In basic terms, you would charge VAT on your goods and services at the full amount of 20 per cent, but then would only pay HMRC back a reduced amount, usually around 13.5 to 14.5 per cent depending on what industry you work in.
That means you get to keep the difference between the VAT collected and the VAT paid back to HMRC.
This difference can provide a significant boost to your income over the course of a year. For example, a freelance IT consultant charging £200 a day for 45 weeks in a year could earn an extra £1,530 during that year from the difference between the VAT collected and the VAT paid back to HMRC at the reduced flat rate.
If registered for the Flat Rate Scheme, you will not be able to claim back VAT you have been charged on goods and services (your input tax), but as many freelancers and sole traders have very few outgoings, it is still beneficial for them to use the Flat Rate Scheme. You also do not need to complete detailed VAT returns outlining all your input tax, so the extra revenue and the simplified VAT returns means many sole traders and freelancers chose the Flat Rate Scheme for dealing with VAT.
You can see a list of the reduced VAT rate you will pay depending on your industry sector, as well as information on income thresholds and eligibility, by visiting our Flat Rate VAT Scheme Guide
|Net amount you invoice your client||£5,000|
|VAT charged on top to your client (20%)||£1,000|
|Flat rate VAT 13.5% (this includes a first year discount of 1%)||13.5%|
|VAT to be paid to HMRC – 13.5% of £6,000||£810|
|VAT received from client||£1,000|
|Profit for you i.e. what you get to keep||£190|
However, there are certain thresholds which cannot be exceeded, for more information see our detailed Flat Rate VAT Scheme Guide.
Cash Accounting VAT Scheme
The Cash Accounting Scheme is another way of dealing with VAT and is often used used by companies who would benefit from only paying back VAT to HMRC once they have been paid by their clients or customers. It also means you cannot claim back VAT on goods or services which you have not yet paid for. The scheme is restricted to businesses with an annual turnover below £1.35m.
As with standard VAT accounting, you will need to fill out a quarterly VAT return detailing your input and output tax.
The key difference is that if you raised an invoice in March but it isn’t paid until June, then you would pay the VAT back to HMRC in the June quarter, not in the March quarter. You do not add an invoice to your quarterly VAT return until the payment is received in full.
Cash Accounting Scheme – the advantages
Cash accounting can be a real boost to the cashflow of businesses that have extended payment terms on their goods or services, or have many clients who do not pay straight away. This is because you do not need to pay HMRC VAT that you have not yet received.
Cash Accounting Scheme – the disadvantages
You have to wait until you have paid for goods in full before you can claim the VAT back on the purchase.
You will need to repay any VAT that may be outstanding on invoices raised if you decided to opt out of the scheme, even if you have not received full payment from your clients.
The information above has hopefully helped you get a clearer understanding of what VAT scheme may be most suitable for your business. But if you would like to read more about VAT for small businesses then you can read our additional guides: