VAT - What every small business should know

Your business must register for VAT with HM Revenue and Customs (HMRC) if, over the past 12 months, your "taxable supplies" (closely based on your sales or turnover, not your profit) have exceeded the VAT registration threshold. This applies to all commercial businesses, whether you're operating as a sole trader, partnership, limited company or another business structure.

The VAT registration threshold is currently £90,000, unchanged since 1 April 2024. It's calculated on a rolling basis, so you'll need to monitor your taxable turnover for a rolling 12 month period, not just in the current tax year, your last financial year or the calendar year. If, at the end of any given month, the total of your turnover over the last 12 months exceeds £90,000, you'll need to register for VAT.

You should also register if your turnover is likely to exceed £90,000 in the next 30 days.

You may even want to register voluntarily if you make significant VAT inclusive purchases and sell mainly to VAT registered customers.

All VAT-registered businesses are now required to keep digital accounting records and file VAT returns through Making Tax Digital (MTD) compatible software — this has applied to every VAT-registered business since April 2022, not just those above the threshold. If you're not yet MTD-compliant we can help you get set up.

>>> See Making Tax Digital for VAT <<<

Imagine you sell widgets to people or businesses that aren’t VAT registered (ie, the public). You currently buy them for £7 (including VAT of £1.17) and sell them for £10.

You currently make a profit of £3 on each sale. If you become VAT registered then you can claim that £1.17 back and now you’re making a profit of £4.17 per sale.

But you’re now VAT registered and you have to charge VAT on everything you sell. If you add VAT to your current selling price of £10, then you’ll be selling at £12. If your customers are VAT registered they won't care as they can claim back the VAT. But if they’re not then the extra £2 has to come out of their pocket.

So essentially your prices are now higher and may mean you customers go to the other widget shop that is now cheaper than you.

You could absorb the VAT – i.e. still sell at £10, but have that as the VAT inclusive price (£8.33 + £1.67 VAT).

So lets look at your profit again.

You buy your widgets at £5.83 (you actually pay £7, but £1.17 can be claimed back)

You sell them at £8.33 (you actually charge £10, but £1.67 goes to HMRC)

So, you now make £2.50 (£8.33 minus £5.83) profit on each sale.

If you do decide to register for VAT, you should be aware that there are a number of schemes available. These are the 3 most popular.

Standard Scheme

On the standard scheme, the amount of VAT you owe (or reclaim) is based on the date of invoices. So if you invoice someone for £1,000 + VAT – that VAT is deemed to be owed to HMRC at the end of the quarter in which you dated the invoice. This can cause cashflow problems for small business.

Cash Accounting Scheme

This solves the cashflow problems associated with the Standard scheme. VAT is deemed to be owed at the end of the quarter in which you were actually paid for the invoice (and on the other side – when you paid for your purchases)

Flat Rate Scheme (FRS)

This scheme can save you money in certain industries.

You get given a flat-percentage rate depending on your industry — let's assume 11%. You then charge VAT at the usual rate but only pay over to HMRC 11% of your gross (VAT-inclusive) turnover.

You can't claim back VAT on your purchases (with a few exceptions), but you don't hand over all the VAT you receive to HMRC.

Since 1 April 2017, businesses on the Flat Rate Scheme that spend very little on goods relative to turnover — known as "limited cost traders" — pay a fixed 16.5% rate instead of their trade-specific percentage. This remains the case today and affects many labour-intensive, service-based businesses such as IT contractors, consultants and hairdressers.

A limited cost trader is one that spends less than 2% of its VAT-inclusive turnover on relevant goods (not services) in an accounting period, or less than £1,000 a year (£250 a quarter) even if that's more than 2% of turnover.

Certain items don't count towards this test, including capital goods, food and drink for staff, and vehicles or vehicle parts (unless running a vehicle-hire business).

See our full Limited Cost Traders & VAT Flat Rate Scheme page for worked examples and whether the scheme is still worthwhile for your business.

Proper VAT invoices must be issued for supplies to VAT-registered businesses.

• A full VAT invoice should include a unique identifying number; the supplier’s name, address and VAT number; the customer’s name and address; the invoice date; the tax point (if this is different from the invoice date); the type of supply (such as sale or rent); a description of and the amount of goods or services supplied; unit price; any cash discount rate; the VAT rate; the total excluding VAT; the VAT amount and the total payable.

• VAT invoice numbers must be sequential, with no unexplained gaps.
• Duplicate invoices must be clearly marked.
• If you issue other documents (eg pro-forma invoices), which show the same details, they must clearly state ‘Not a VAT invoice’.

If you make retail sales under £250 (including VAT), you can issue customers with a ‘less detailed’ VAT invoice.

• This must show your name; address; VAT number; the date of supply; a description of the supplies; the amount (including VAT) and the VAT rate charged.

You must cancel your registration if you’re no longer eligible to be VAT registered. For example:

• you stop trading or making VAT taxable supplies
• you join a VAT group

You can ask HM Revenue and Customs (HMRC) to cancel your registration if your VAT taxable turnover falls below the de-registration threshold of £88,000.

How to cancel - You can apply to cancel your VAT registration:

• online - through your VAT online account
• by post

You must do this within 30 days of your reason for cancelling the registration or you may be charged a penalty.