VAT as a limited company: Value Added Tax overview for PSCs
Only the other day a contractor compliance expert spoke of a scheme for VAT without even putting the words ‘Value Added Tax’ before it. We’re all guilty of that a bit, because VAT is so common, so well-known, so ingrained in everyday life, that the 1973 levy is often overlooked.
Well no more. Let’s consider many things VAT that you may not know or fully understand. Exclusively for ContractorUK, these are the ins and outs of Value Added Tax for Personal Service Company directors and others in the contractor sector, writes Christian Hickmott, chief executive of Intergro Accounting.
What is VAT?
VAT is the tax that applies to almost all goods and services in the UK.
There are three different rates of VAT:
- Standard Rate (currently 20%),
- Reduced Rate (currently 5%); and
- Zero rate
There can also be items that can be exempt from VAT, such as rent, salaries and dividends, or outside the scope of VAT, such as when you purchase items abroad.
When should contractors register for VAT?
There are simple rules for when you have to, legally, become VAT registered. This is when:
- The gross income of your company is, or exceeds, £85,000 per year. The threshold can change each year so we advise that you check the HMRC website regularly or speak to your accountant for advice.
- Your VAT-taxable turnover is expected to exceed the threshold in a single 30-day period.
Even if the above criteria do not apply to you, you may decide that you want to voluntarily become VAT registered. There are a number of reasons that you may do this:
- Because reclaiming VAT on your expenses may be beneficial to your business.
- If most of your clients are large companies that are VAT registered, it could work to your advantage, making your business look more credible in their eyes and put you on an equal footing.
- If you can register for a reduced Flat Rate (on HMRC’s VAT Flat Rate scheme). Being part of this scheme can reduce the admin (and therefore potentially the cost) of preparing your quarterly VAT return.
Who does your VAT registered company invoice?
Although there are benefits to voluntarily registering for VAT, your contractor business would also need to consider who you will be invoicing.
For example, if you are invoicing another VAT registered business then this is not likely to affect you or your business as they can simply claim the VAT back on your sales.
But if you are invoicing a client who is non-VAT registered, then they will not be able to claim the VAT back. This could make your rates less competitive against other contractors as you will ultimately be charging an additional 20% on your net rate which a non-VAT registered contractor would not need to add.
Once you become VAT registered it is imperative that you keep records of all sales and purchases.
What type of VAT schemes does HMRC offer?
PSCs have several options of VAT schemes to register for.
- Standard Rate VAT scheme
You invoice your client at the standard rate (20%) and in turn repay VAT to HMRC based on the total VAT you have charged, less any VAT you have paid out. Pretty standard, as you can see!
- Cash Accounting scheme
This is very similar to the Standard Rate scheme. The difference, though, is that you only need to pay VAT to HMRC once you have received the VAT from your client. Likewise, you can only reclaim VAT on purchases once you have actually paid the supplier. The benefit of this scheme is that it can help with cashflow.
- Flat Rate VAT Scheme (or ‘FRS’ for short)
Historically popular with contractors, under this scheme you still charge your client at the standard rate, but you only pay HMRC a fixed percentage of your quarterly turnover. The percentage will be determined by the industry you are in.
Importantly regarding the FRS, while it has long-been the most popular of the three options for small businesses, HMRC introduced a ‘Limited Cost Trader’ category which, detrimentally to contractor take-home pay, most contractors fall into. This percentage is 16.5%, meaning contractors collect £20 of VAT and pay £19.80 on every £100 invoiced.
Regardless of what sounds good to you, it’s always worth talking to your accountant about which VAT scheme will suit you best, as each has their own benefits and drawbacks and obviously, you want to maximize the former and minimise the latter! Things to consider include your turnover, your VAT-able expenses, and the types of clients that you work with.
Which is the most beneficial VAT scheme for PSCs?
See what your adviser says but generally-speaking, the VAT Flat Rate Scheme was always the scheme which was most frequently recommended for PSCs. But due to the increased rates brought on by the new category on this scheme from April 2017, it now very much depends on the contractor’s individual circumstances, as to how beneficial it is.
Our recommendation to contractors who sign on with us is that they initially register for the FRS. This is because there is a 1% discount offer available during the first year of trading. After this, it’s necessary to review on a quarterly basis as it may be more beneficial to switch over to the Standard Rate VAT scheme.
Remember; every company is unique and individual circumstances need to be taken into consideration when deciding which VAT scheme is best. Talking to your accountant for guidance as soon as you decide to, or realise that you need to, become VAT registered is the way to go.
How to sign-up and register for VAT?
This is a simple process, usually completed online and Gov.uk has all the information and forms you need. Another reason we recommend getting your accountant on board with your ‘to register or not to register’ decision is that they should be able to sign-up your company on your behalf. Once you’ve applied, HMRC advises that your registration certificate should come through within 14 days, but it can take longer than this.
While you’re waiting for your registration number to come through, you cannot charge VAT on your invoices. However, you can increase your costs by 20% (which is the standard rate of VAT), and then re-issue those invoices with the correct VAT breakdown once you get your number.
Where does Making Tax Digital come in?
The government is trying to make it easier for companies to get their tax correct by ‘Making Tax Digital.’
All VAT registered businesses with a taxable turnover above the VAT threshold of £85,000 are now required to follow the Making Tax Digital rules. This means keeping digital records and using software to submit VAT returns. This applies to first returns starting on or after April 2022. Those below the £85,000 threshold can voluntarily join the service but don’t have to. And VAT returns (digital or not) need to be filed every three months. Failure to do so in a timely fashion can result in penalties from HMRC.
Are there other VAT considerations?
Despite its long-winded name, Value Added Tax isn’t particularly complicated. But contractors do need to keep on top of it. For example, failing to register for VAT or making late VAT payments to HMRC can incur pretty heavy fines, so always be aware of what your business is making and when you need to act.
Your accountant can file your VAT returns for you if you don’t want to do the filing yourself. This alone should take away most of the pressure, as should the preliminary conversations with them of whether to register and if so, under which of the three schemes. Technical types of contractor might be interested in our follow-up to this VAT overview, in which we’ll delve a little deeper into VAT, crunch some numbers, chart some examples and tot up its wider implications, including under IR35 reform and contracting overseas.