One of the dilemmas new business owners face when setting up a limited company is whether or not to register for VAT.
Whilst registering for VAT is a legality, this only comes into force once a business’s taxable turnover exceeds the current £85,000 threshold.
However, some new businesses deliberate over whether to undertake voluntary VAT registration as part of their incorporation, even if they do not expect to exceed the threshold in the immediate future.
Registering for VAT is a decision worth thinking over as it does come with both benefits and drawbacks. Before we get into those, let’s remind ourselves what it is.
The Meaning of VAT:
In the United Kingdom, VAT stands for Value Added Tax.
VAT, or Value Added Tax, is classed as a consumption tax that is placed upon a product throughout varying stages of its supply chain. Most commonly this is limited to just UK products and services, however it can include imported products from some EU and non-EU countries as import VAT is applied at the UK border.
In 2022, the current VAT rate is 20%. This rate is the amount a customer will pay on top of the cost of their product.
There are items which are exempt from VAT however or which incur a lower VAT rate of 0%, 5% or 12.5%.
Though customers may have to pay 20% on products and services, VAT registered companies can reclaim any VAT paid from HMRC when buying products or services.
This is just one example of the fine line between benefits and drawbacks that VAT offers.
The Pros and Cons of Being VAT Registered:
Though it may seem an unnecessary decision to make before reaching the £85,000 threshold, some businesses decide to voluntarily register long in advance. This could be for a multitude of reasons, including convenience, box checking, but also to reap the benefits that VAT registration does provide.
These benefits are as follows.
Pros for VAT registered businesses
- The ability to claim VAT, and add 20%, on goods and services sold. This is referred to as the output tax.
- If a VAT registered business makes purchases from another VAT registered business, the business can claim the money back from HMRC. This is particularly useful for new businesses who may need to make purchases like equipment and stationary to get themselves started.
- From an opposite perspective, businesses that are VAT registered could prove attractive when it comes to selling goods and services to other businesses. Businesses wanting to purchase from the company will already know they can claim the VAT back, sweetening the deal over competitors who may not be registered. Whilst the cost is ultimately the same in both cases, many businesses are drawn in by the notion of being able to reclaim VAT. For new businesses especially, more ways to attract custom is never a bad thing.
- Displaying that the business is VAT registered with a VAT registration number adds credibility and trustworthiness to the business’s image. Not only does this reassure customers who may be wary of purchasing from a new business, but it will also be beneficial when enticing investors later down the road.
- For businesses under the threshold, registering for VAT acts as an added layer of protection. Businesses who aren’t VAT registered are essentially announcing to prospective customers, competitors and investors that they are turning over less than the VAT registration threshold. This can damage the business’s image, especially if the industry it is operating in requires it to look experienced or established. Plus, announcing a low threshold could leave the business vulnerable to losing potential investors for fears of low turnover.
- If a business registers for VAT, any VAT they did incur in their startup costs, such as buying equipment can be reclaimed and returned to the business through HMRC. For goods it’s possible to reclaim VAT on purchases in the last four years, whilst for services you can look back six months. This reclamation could provide much needed funds to a business in it’s early days, as opposed to waiting and hoping it makes the threshold.
Make sure you check out the 6 simple tax mistakes to avoid if you’re registering for VAT
As we spoke of earlier, the benefits of registering for VAT unfortunately do come with drawbacks. The potential cons of registering for VAT are:
Cons for VAT registered businesses
- Businesses that predominantly deal with non VAT registered businesses may risk losing those businesses to competitors because of higher prices. This is because the amount charged to customers has to increase in order to account for VAT on all taxable income. As your customers won’t be able to reclaim this VAT, it will increase the cost of your goods or services to them. For newer or smaller businesses, this extra cost could dissuade vital customers.
- Complex and additional administrative work. Depending on which returns you submit, you will need to submit either monthly VAT returns or quarterly VAT returns. These documents must abide by stringent VAT record keeping rules and requirements, which can take time to both understand and get right. Businesses will also need to issue valid VAT invoices, which can create more paperwork for both the business owner and customers.
- Businesses who breach the VAT record keeping rules and requirements could be subject to receiving financial penalties. Though HMRC can be lenient with initial mistakes when dealing with a new business, repeated mistakes in VAT accounting records will lead businesses to paying hefty fines. At Raw, we’re an accounting firm specialised in small businesses, so we can help you understand these regulations and take care of them on your behalf.
- Businesses may need to pay significant VAT bills. If a business’s output VAT ends up being higher than its input VAT, as is common with new or small businesses, then the difference must be paid to HMRC. At 20%, this can often mean paying an inconvenient and large VAT bill which could have damaging consequences on the business, especially if it has tight cash flow, and no reserve funds.
In Conclusion:
If you are a business owner whose business is under the VAT threshold it is well worth weighing up this set of pros and cons before deciding whether to register.
Cons like higher costs and potential VAT bills are things to keep in mind for startups, or small businesses who temporarily have limited cash flow. But an air of authority and credibility for investors, as well as the ability to reclaim VAT from other businesses could have a positive impact on that business’s cash flow.
There are a number of VAT schemes, like the flat rate scheme, which can provide a sensible middle ground for some growing businesses not yet above the threshold. It is important to check that such a scheme is right for your business.
At Raw we specialise in helping small businesses make the correct financial choices, and we’re experienced in both VAT and HMRC’s record keeping and regulations. For more information on how we could help take the administrative work from you, contact us today. Or alternatively, visit our small business accounting page to see more of our services.
