Wondering what ‘VAT’ is all about? In this video Dan runs you through some examples of how VAT works, and how it affects your business.

Are you wondering how VAT works? Well in this video I’m going to give you a brief overview of how it works and why it might be or might not be a good idea for your business.

As a business accountant my team and I spent all day helping clients with tax and their VAT now it’s one of these things where VAT is not a particularly well understood topic I think even accountants find it one of the more difficult taxes to deal with because there are so many rules and it is reasonably complex.

However, from a basic understanding point of view there are some key concepts that I wanted to share with you today. If you do enjoy these types of content be sure to click the subscribe button below so you can get notified whenever we release another video.

Now let’s start with the basics so I am going to say here as a disclaimer because of the reasons I’ve already spoke about, VAT is very complex and as a result what I’m talking here is very broad brush. I’m just going to give you a wide overview and in the majority of circumstances rather than looking at specifics.

So to start with what we should say is VAT is a consumer tax, an indirect tax, as it’s known and all that means is that it’s paid by the people buying the products and the services ultimately those VAT registered businesses in the chain aren’t really paying it. But they are acting as tax collectors for the government, which we shall explain shortly.

So it’s actually you the end user that ends up paying VAT. So something that’s always interesting to me is people pay every day and don’t really realise it you know some of your shopping will have it on there, you know if you buy tv your TV is going to have it on there. All those types of services I have I’ve got on there but people don’t really get upset about it. But it’s interesting when they’re displayed on something like they’re buying a new boiler say or they’re getting a builder to come in and build something in their home.

They can then see the extra VAT on the invoice and they start to get a bit concerned about it, but it’s interesting that that seems so different depending on exactly where you see this VAT and whether it’s hidden or not. So yeah you pay every day on everything you probably just don’t realise it.

So here in the UK we’ve got quite a high threshold as it’s known and all that means is that businesses don’t have to register for VAT until they reach at least £85,000 in a 12-month period. Now that’s quite an important thing the VAT threshold and it’s probably another video and another tip. But it’s very easy to get yourself caught out but if you just think about when you get to around 85 grand in a 12-month period for the first time those businesses have to register.

You can actually do less than that and register you can register from day one with no turnover if you like as long as you’re trading and sometimes there’s some really really good reasons to do that. And generally what we find is as a general rule if you’re dealing with the public, it’s not necessarily a good idea to register from day one but if you’re dealing with bigger VAT registered businesses that don’t care about the VAT you’re charging for the reason I’m going to explain then often it makes sense to register from day one.

So the way it works is, just imagine you as a consumer you’re paying all this extra VAT to the business, so if you imagine using an example of £120 TVs nice cheap TV, every £20 that the business is collecting, they’re going to hand over each quarter month year depending how they do their VAT, there’s various different options to revenue and customs, so they’re just collecting it on your behalf.

What they’re able to do though this is if they’re able to offset any VAT that they’ve paid out before they hand it over, which basically means they get to reclaim the VAT. It doesn’t feel like a reclaim because most the time they’re still handing money to the government. However, it’s a lot less than the money they’ve collected on their behalf. So, that’s quite an important concept which is why it can be good to VAT register is because you can reclaim your VAT you’re incurring.

So you know quite often, that’s mobile phone bills, if you’re in business, it’s going to be things like accountants, some rent, lots of different things that you’re going to incur the VAT on if you’re in the building game, you know your building materials have got it on.

Now it’s a good point to say there are some things that the government set and say they’re zero rated so they are vatable services, it just happens to be that there’s zero percent VAT on them and then some things are outside of VAT.

Some things are exempt in VAT and ultimately you just don’t pay VAT on them. There’s a lot of technical reasons why they’re different and important, but for now there are some things that you won’t pay VAT on and there are some businesses as a result that charge services that are exempt from VAT that can’t be VAT registered. So not all businesses must be VAT registered in different circumstances. So for you it’s worth checking with a professional to make sure where you sit with that, but for the majority of people when you get there when you get to the 85k limit. You’re going to have to have review on your own figures in your own pricing to make sure that’s okay because you get 30 days to register from the point that you get there.

So, let’s do an example of how VAT works in practice. Let’s choose a handcrafted handmade chair, now the chair normally sells for a hundred pound and the materials the wood that’s used to make it sell for 60. Now when we look at the receipts in detail we see that the wood for the chair is actually £50 plus VAT, that’s the breakdown on the receipt so, but still the business is paying £60 so you’ve got £100 take away £60 equals £40 so they’re making £40 now if they were to VAT registered tomorrow.

Their £100 would become £120 chair and their wood that they’re buying is still £60 so, what happens is they get the £20 extra from the customer and they’d normally hand that over but because they’ve incurred £10 on this chair on the wood they’re able to offset the £10. So they have 20 take away 10 they hand over £10 to the tax man, sounds really good and as a result what then happens is they’ve made 50. So they’ve still got their original £100 and their cost is now only £50 because they’re able to offset this extra £10 from the tax man. Well the keen eyed there if you will have noticed that of course you’re now charging the customer £120 that they might not be very happy about it.

So as a result, if you’re dealing with the public as we mentioned earlier this can cause some pricing issues because if the person down the road is selling the same chair for 100 because he’s not VAT registered and you’re 120, some customers are going to ask the question about whether they should be shopping with you or them. And of course at that point it’s then looking at different ways to differentiate yourself as a business to make sure that people want to come and shop for you for more reasons than just pure price.

However, you could of course still sell it for £100. Now the impact of that means that the taxman is still going to take some VAT money from that £100, so if you work it backwards what it really means is you’re now only charging £83.33 for the chair so when you when you charge £100 you’re going to take £16.67 and hand that to the VAT man, and again you’re going to be able to offset your £10 from your wood that you’re buying so you’re only handing them over £6.67.

However you’ve only taken roughly £83, so you think you’ve got £83 in, £50 of cost you’re only now making £33 instead of the £40. In the original example, or the 50 in the other example. So you can see pricing is one of those difficult things.

But going back to the example where you can just add 20 on. If that was being supplied to a commercial dealer who was a big company big retailer who were VAT registered already, they’re not going to be interested and worried about the VAT that you’re charging that extra £20 because they can reclaim it and the result you’re winning. So, in that scenario quite often you’d want to register from day one if nearly all of your customers were VAT registered customers.

So, hopefully you can see how that works in practice and that’s the basics of VAT. However one of the things as a business that’s worth mentioning is now we have a thing called making tax digital, it’s a scheme from revenue and customs, that means that you now need software to be able to submit your VAT returns, you must keep digital records and they must be transmitted digitally.

Now, that doesn’t mean that you need photos of everything it just means that you need to actually store the transaction data. So if you imagine a big spreadsheet of names, dates, amounts and everything that’s really the data that right now is what they want you to store so as a result you can still use a spreadsheet you normally need a bit of software that plugs into that spreadsheet to transmit your VAT return. So if you are becoming VAT registered that’s something to be wary of.

And the only other thing I really want to mention of course is that, again the keen listener may have noticed, that in theory what happens then if I’m selling, if I’ve not sold anything but I’m buying loads of stuff does that mean I can get a VAT refund? And the answer is yes, you can and actually in a lot of circumstances that is quite a normal thing. So you can get a VAT refund if you end up buying more stuff and spending more VAT. Then you’re actually getting in in money. So in start-up mode or times like in the coronavirus, or something like that, there might be times where you’re not selling a lot but you are actually stocking up and buying things and as a result you may well end up in a reclaim, and how that comes back to you, and how regularly depends on how you pay your VAT.

And that’s it that’s the basics of VAT for your business. If you’ve enjoyed this video please do share it with your networks and we’ll see on the next one.

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