One of the dilemmas new business owners face when setting up a 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 voluntarily register themselves 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.
(Source)
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.
In 2020, 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 exempt from VAT however, and we cover them in more detail in our blog, When to Register for VAT.
Though customers may have to pay 20% on products and services, businesses who are VAT registered and buying products or services can reclaim any VAT paid from HMRC.
This is just one example of the fine line between benefits and drawbacks that VAT offers.
(Source)
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:
- The ability to charge 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 stationery to get themselves started.
- From an opposite perspective, businesses that are VAT registered could display an attractive USP 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. For new businesses especially, more ways to attract custom is never a bad thing.
- Displaying that the business is VAT registered 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 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 turnover could leave the business vulnerable to losing potential investors for fears of low turnover, as well as being negotiated into bad deals.
- If a business registers for VAT, any VAT they did incur in their startup costs, such as buying premises or necessary equipment can be reclaimed and returned to the business through HMRC. This reclamation could provide necessary and much needed funds to a business when it needs them, as opposed to waiting and hoping it makes the threshold.
As we spoke of earlier, the benefits of registering for VAT unfortunately do come with drawbacks. The potential cons of registering for VAT are:
- Businesses that predominantly deal with customers who may not be VAT registered may risk losing business 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. 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 who breach the VAT record keeping rules and requirements could be subject to receiving financial penalties. Though HMRC are lenient with initial mistakes when dealing with a new business, repeated mistakes will lead businesses to paying hefty fines. At iFinance Department, 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%, these bills can often be inconvenient and potentially damaging, especially if the business 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.
At iFinance department 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.