31
VAT
One subject that is guaranteed to raise ire among small businesses is VAT.
Essentially, the VAT system is operated by businesses acting as tax collectors
for the government. As far as the consumer is concerned, it is what is called
an indirect tax. It is only paid by the consumer when something is bought,
but the amount of VAT cannot be claimed back by a consumer. As far as you
the business person is concerned, you pay tax when you buy goods from
someone else and charge the tax when you sell them on. Broadly speaking,
you hand over to HM Revenue & Customs* (HMRC) the difference between
the amount of tax you charge your customers and the amount of tax you
have paid your suppliers.
What is in this chapter?
how the VAT system works (p. 420).
who has to register? (p. 420).
what rate of tax? (p. 423).
voluntary registration (p. 424).
how is the tax worked out? (p. 425).
the records you need (p. 427).
paying the tax (p. 430).
compulsory online ling (p. 431).
VAT is a complex tax, and this chapter can only outline the principles. The
examples given are deliberately simplied. You are advised to ask for profes-
sional help with VAT if your affairs are at all complicated.
420 The Financial Times Guide to Business Start Up 2012
How the VAT system works
The principle of the system is that tax is paid on the value added at each
stage of the business process.
Example 1
Jason King grows timber. He sells £1,000 of oak to A. J. Furniture, which will turn the
oak into hand-crafted timber. He charges £1,000 for the timber and adds on 20 per
cent to the invoice for VAT. The total A. J. Furniture pays to him is £1,000 plus £200
VAT, £1,200 in all. Jason pays the £200 tax collected (called output tax) to HMRC
*
.
A. J. Furniture makes the oak into ten tables. These are sold on to a furniture shop
run by Doris Bates. Doris is charged £250 for each table plus VAT. On the invoice,
this is shown as £2,500 plus £500 VAT. A. J. Furniture claims back the VAT charged
by Jason King (called input tax), that is, £200, and hands over the VAT Doris pays to
them, £500 (called output tax). This means a net payment of £500 2 £200 5 £300
to HMRC.
Doris sells the tables in her shop at a price of £500 plus VAT. She receives in total for
the tables, £5,000 plus VAT of £1,000. When she makes her VAT return, she claims
back the £500 VAT (called input tax) she paid to A. J. Furniture, while handing over
the £1,000 VAT paid by the customers (called output tax), a net payment of £1,000
2 £500 5 £500.
The customers cannot claim back the VAT they have paid on the tables, but all the
businesses are registered for VAT and can do so.
VAT is charged on what is called taxable supplies. In Example 1, Jason King
makes taxable supplies (the timber) of £1,000, A. J. Furniture makes taxable
supplies (the tables) of £2,500 and Doris makes taxable supplies of £5,000
(the tables). Not all goods supplied to businesses are taxable; some are
known as exempt, and VAT is not charged on those (see p. 421).
In VAT terms, the VAT that you charge on what you sell is called your
‘output tax’. If registered for VAT, the business to which you sell claims
back the VAT that it pays you as its ‘input tax’. This is done when it makes
its VAT return to HMRC.
Who has to register?
It is the person, not the business, who is registered for VAT. Each registra-
tion covers all the business activities of the registered person. For VAT
purposes, a company is treated as a person. There are a number of reasons
why you might not have to register. These include:

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