As a business owner it’s inevitable that you will pay VAT on the majority of goods and services you purchase in the running of the business. And, as most goods and services attract VAT at 20%, that’s a big cost to your business.
But VAT is designed to be paid ultimately by the end consumer of the goods or services, not by the businesses that supply them.
Fortunately, you may be able to reclaim the VAT you pay out for goods and services related to your business. So, let’s look at how that works.
Who can reclaim VAT?
Firstly, in order reclaim VAT your business must be VAT registered. A few types of business are exempt from VAT, including those dealing in insurance, educational training, art, and antiques.
If your business deals only in VAT exempt goods or services, then it is not allowed to register for VAT, and won’t be able to reclaim VAT on business costs.
What about businesses dealing with zero rated goods and services?
Being VAT exempt is different to “zero-rated” goods and services. In this case the goods or services are still chargeable to VAT but at a rate of 0%. The main categories of business that are zero-rated are health, food, children’s clothing, and publishing.
Food does not include alcohol, and not all food is zero-rated. Just to confuse things, businesses that prepare and sell food for consumption on the premises do not generally fall into the zero-rated category.
If your business deals with zero-rated goods or services, it can still be VAT registered and reclaim VAT on the purchases it makes.
For some businesses this can work out rather well. Even though you might mainly sell zero-rated goods and services on which your customers will pay 0% VAT, you will probably have costs which aren’t zero-rated, such as fuel, stationery, and IT services.
It effectively means that you’re paying more VAT to your suppliers than you’re collecting from your customers and as such, you can reclaim the difference from HMRC. As long as your business is VAT registered you can reclaim VAT on most of your business’s costs. It’s why some businesses find it helpful to register for VAT voluntarily!
How does reclaiming and charging VAT work?
When your business registers for VAT, you must charge VAT at the appropriate rate on all goods and services you sell (apart from any that are exempt). You’ll need to issue your customers with a VAT invoice which shows the amount of VAT they are paying.
You must also keep the VAT invoices for any goods and services you purchase in the running of the business. When you make VAT submissions you’ll pay or reclaim the difference between the VAT you charge to your customers, and the VAT you pay out.
Reclaim the difference: if the VAT you pay out on purchases is more than the VAT that you charge and collect from customers
Pay the difference: if the VAT you pay out on purchases is less than the VAT that you charge and collect from customers
Most businesses do this quarterly (every 3 months) but there are different VAT accounting schemes with slightly different requirements.
This is the accounting scheme that most businesses use. Under this scheme, you record VAT on every purchase and every sale and make a VAT submission to HMRC every quarter. You pay or reclaim the VAT due at that point.
Annual VAT accounting scheme
Some businesses are allowed to use an annual accounting scheme, and only make a VAT submission to HMRC once a year. You’ll pay an estimate of what’s due based on your previous year’s VAT bill.
You can either make payments in quarterly instalments, or monthly over 9 months. Any under or overpayments will be dealt with at the next annual return.
Certain types of business are allowed to use this scheme, and the list is quite extensive. The scheme is, however, limited to businesses with an annual taxable turnover of £150,000 or less.
Under this scheme, you avoid all the VAT accounting requirements and simply pay a flat rate of VAT based on a percentage of your annual turnover. The percentage you pay is based on the industry you are in.
Although you’ll still charge customers the full appropriate rate of VAT depending on the goods or services you sell, you won’t be able to reclaim the VAT you pay out apart from for capital expenditure over £2000.
The idea behind the scheme is that paying a lower rate of VAT to HMRC compensates you for not being able to reclaim the VAT you pay out, because you’ll still be charging the standard rate of VAT to most of your customers.
Our simple to use bookkeeping software, Pandle, is fully compliant with MTD and takes the headache out of quarterly VAT returns.
Reclaiming VAT on vehicle and fuel costs
One of the main rules relating to reclaiming VAT is that the costs must relate solely to business purposes. It’s why VAT can get a bit complicated in the case of motor vehicles.
There is often an element of private use where vehicles, especially company cars, are involved. But even though it is a complicated area, it’s important to know what you can and can’t claim.
Overclaiming VAT costs will attract action from HMRC, but underclaiming may be costing your business VAT that you could legitimately reclaim. There are different ways around this and we deal with it in a separate article, which you will find here.
Reclaiming VAT incurred before registering
It’s quite common for businesses to register for VAT some time, often years, after they started trading. This might be because turnover did not previously exceed the VAT registration threshold of £85,000, or the business has changed in some other way.
It’s quite possible that expenditure incurred before registering for VAT was for goods or services that are still being used in the business after registering.
The good news is that it’s possible to reclaim the VAT you paid on goods bought up to 4 years before registering, and for services up to 6 months before.