So, there you are, happily working away in your new business, doing decent monthly revenues and hitting your profit targets, when BOOM, someone (maybe your accountant, maybe just a mate) tells you that you need to look at VAT registration. Now, depending on the business you are in, and, more importantly the market you sell into, this can have far reaching implications. First, a quick explanation of VAT registration and it’s requirements:

Any UK business with a turnover in “VAT Taxable supplies” exceeding £85,000 (the “threshold”) in any twelve month period, is required to register for VAT.

VAT taxable supplies are any sales which are not VAT exempt. Zero rated supplies – such as most foodstuffs, children’s clothes etc – are not exempt. Rather, they are charged at 0%, so if you’re in a business which is selling zero-rated good or services you still need to keep an eye on the VAT.

The twelve month period is calculated on a rolling basis and has nothing to do with your financial year. When looking at whether you should be registered for VAT, you should always be looking backwards at the twelve months just gone. We are in February just now, so we should be looking to see if the turnover in the year ended 31st January has gone over £85,000. If it has, it’s time to join the VAT club.

The implications of registering for VAT can vary dramatically depending on what you do, and just as importantly, who your customers are. Generally, the winners are B2B businesses and those selling zero rated goods or services. If you sell standard rated goods or services to the public, then you’re going to lose out.

B2B selling

If you sell to other businesses, the chances are these business will also be VAT registered and therefore will be able to reclaim the VAT you charge them on their own VAT return, so they are financially neutral. You, on the other hand, as a VAT registered trader, can generally claim VAT on all your VATable expenses, meaning your costs are reduced.

Selling zero-rated goods

If you sell zero-rated (not VAT exempt) goods or services, then you’re likely to be financially better off being VAT registered. While you don’t pay VAT on your income, and likely most of your directs costs will be VAT Zero-rated as well (and therefore there’s no VAT to reclaim on it), you will no doubt have VAT to reclaim on expenses such as advertising, vehicle expenses, computers and other machinery, again, meaning your costs are reduced.

Selling standard-rated goods or services to the general public

It’s these “retail” businesses which are hardest hit: Because the customer is unable to reclaim the VAT, it is just part of the cost. So, if you register for VAT and want to pass the VAT onto the customer, you’re going to experience some resistance. A £3 product suddenly becomes £3.60, or a £1,000 window replacement goes up to £1,200. That’s a fairly hard sell, so in reality what happens is the retailer or service provider is forced to absorb the VAT into the cost. So, the customer only pays the £1,000, but the has to pay £166 in VAT.

It’s worth taking a minute at this stage to point out that the cost structure of the business will have a huge difference on the actual impact VAT registration will have. Here are four very different businesses who will all feel the force of the VAT tipping point, but, as you can see, the impact varies massively.

Example 1: The Rose and Crown pub

Most of the costs associated with running a pub, and certainly all of the goods purchased for resale will be standard rated so VAT can be reclaimed on these. The annual cost of being VAT registered at just above the threshold is likely to look something like this:

Turnover£86,000£14,333
Costs£30,000£5,000
VAT payable£9,333

Example 2: Curlers hairdressers

Most of a hairdresser’s costs are for staff and therefore no VAT can be reclaimed there. Although they will pay VAT on stock, and expenses, these costs probably only represent about 20% of the income, so the VAT impact is much more stark:

Turnover£86,000£14,333
Costs£17,200£2,867
VAT payable£11,467

Example 3: Bryan’s Burgers

Here’s the business that is likely to be hardest hit: When you buy uncooked food it is generally zero-rated but the minute you cook it, it becomes standard rated. This applies to restaurants as well as hot food takeaways. Again, the overheads are likely to be heavily weighted toward staff and therefore very little can be reclaimed in the way of VAT.

Turnover£86,000£14,333
Costs£8,600£1,433
VAT payable£12,900

Example 4: Waters & Co plumbers

We’ve used plumbers in this example, but it could easily apply to joiners, landscape gardeners, electricians or any other trades who are supplying the general public. Low overheads and materials cost means quite an impact:

Turnover£86,000£14,333
Costs£12,900£2,150
VAT payable£12,183

Minimising the impact

The flat rate scheme

It’s worth looking at the Flat Rate Scheme to see if this will ease the pain. The flat rate scheme means that, rather than calculating your VAT payable like we have in the examples, you just need to pay a fixed percentage of your turnover. The rates are shown here and in the first year, a 1% discount is available. There is a turnover threshold of £150,000 for the FRS so if you expect your turnover to exceed this, you cannot join.

Ensure your costings account for VAT

When starting out and you’re doing your costings and setting your prices, it’s a good idea to do this as if you were VAT registered. That way, when you do become VAT registered, the profit will of course still fall, but it will fall to a level that is acceptable to you.

Splitting the business

This is a contentious issue and should be considered very very carefully. It may be appropriate to split the business into two parts so that one, or both, trade below the VAT registration level. There are two major considerations here: the ownership of the two business MUST be different, and the two businesses MUST NOT HAVE common financial, economic or organisational links, so separate insurance, phone lines, staff etc. Understandably, HMRC do not like this kind of operation, and “artificial dis-aggregation” as it is known, is frowned upon. I could write a whole article (I just might) on this issue alone so please do not consider without seeking expert professional advice. It’s very contentious, and if you get it wrong it could prove VERY expensive.

Just don’t exceed the threshold

I had a meeting with a hair salon owner this week whose current accountant gave them just this advice. On the face of it such growth inhibiting advice seems ridiculous. When you delve a little deeper it’s still ridiculous in this case, but in some instances it may be decent advice. Most business expect to grow, so a business just reaching the tipping point of £85,000 now will likely have ambitions to get to £120,000 next year and on, and on. There are some business for whom growth is not possible, or is not desired by the owners. That being the case, and I hate myself for saying this, it may be better to turn away business than exceed the threshold: It’s better to do £84,000 of business and pay no VAT, than do £90,000 and pay £11,800 VAT.

Conclusion

The VAT tipping point is a very difficult issue and one which really needs an expert head to work through it with you. Oftentimes, it’s best just to bite the bullet and ensure that you have a robust business with a good pricing structure that means VAT registration is just another cost of doing business. Yes, it feel unfair if you’re quoting against non-VAT registered businesses but remember all of the competitors that are bigger than you have had the same problem and have come through it, and so can you.