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Value Added Tax (VAT) is a tax applied to the consumption of goods and services in the UK. It is collected at each stage of the production and distribution process, with the end consumer bearing the cost. As a UK business owner, it is vital to have a thorough understanding of VAT and its impact on business operations and profitability. This article aims to provide a comprehensive overview of VAT, including the differences between flat rate and standard VAT and their effects on business profits, supported by practical examples.
Understanding VAT
VAT is levied on most goods and services registered businesses in the UK provide. It is charged as a percentage of the product’s price and currently stands at a standard rate of 20%. There are also reduced rates of 5% and 0% applicable to specific goods and services. Businesses must register for VAT if their taxable turnover exceeds the current threshold of £85,000 in 12 months.
Flat Rate VAT Scheme
The Flat Rate VAT Scheme is designed for small businesses with a taxable turnover of £150,000 or less, excluding VAT. Under this scheme, businesses pay a fixed percentage of their VAT-inclusive turnover to HMRC as VAT instead of calculating the difference between the VAT they charge their customers and the VAT they pay on their purchases. The fixed percentage varies depending on the type of business and is generally lower than the standard VAT rate.
Consider a graphic design business with an annual turnover of £100,000, exclusive of VAT. Under the standard VAT scheme, the business would charge its customers £20,000 in VAT (20% of £100,000). Assuming its VAT-eligible expenses amount to £10,000, the business would claim £2,000 in input VAT (20% of £10,000). The total VAT payable to HMRC would be £18,000 (£20,000 – £2,000).
Under the Flat Rate VAT Scheme, the business would apply a 14.5% flat rate to its VAT-inclusive turnover (£100,000 + £20,000 = £120,000). As a result, the total VAT payable to HMRC would be £17,400 (14.5% of £120,000). In this case, the business saves £600 in VAT using the Flat Rate VAT Scheme.
Standard VAT
The standard VAT scheme requires businesses to charge 20% VAT on their sales (output VAT) and claim VAT paid on eligible purchases (input VAT). The difference between the output and input VAT is then paid to HMRC.
Consider a retail business with an annual turnover of £200,000, exclusive of VAT. The business would charge its customers £40,000 in VAT (20% of £200,000). Assuming its VAT-eligible expenses amount to £50,000, the business would claim £10,000 in input VAT (20% of £50,000). The total VAT to HMRC would be £30,000 (£40,000 – £10,000).
The Impact of VAT on Profit
A business with a turnover of £100,000 and expenses of £50,000 would have a profit of £50,000 (£100,000 – £50,000). While registered for
Standard VAT scheme: The business would charge its customers £20,000 in VAT and claim £10,000 in input VAT. The total VAT payable to HMRC would be £10,000. The business’s profit after VAT would be £50,000.
Flat rate VAT scheme: Using a flat rate of 12%, the business would pay £14,400 in VAT (12% of £120,000, which is the VAT-inclusive turnover). The business’s profit after VAT would be £45,600.
Business owners need to understand what VAT is and what it means for their business. Choosing the right VAT scheme can greatly impact how much money your business makes. For example, if you have a small business with only a few expenses that qualify for VAT, the Flat Rate VAT Scheme might be good for you. This scheme makes figuring out how much VAT you owe easier and can save you money. But before you decide, it’s important to talk to a tax professional who can help you determine which VAT scheme is best for your business.
If you need help to plan your taxes, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.