Understanding VAT schemes

When you register for VAT for the first time it’s important to choose the right VAT scheme for your business. The scheme you choose has implications for how the VAT you owe is calculated and how often you have to file a return with HMRC. It’s an important decision because it will have an effect on your cashflow. 

 

The standard VAT scheme is the default when you first register for VAT. You pay VAT to HMRC each quarter based on the difference between the VAT you have charged on your invoiced sales and the VAT you have paid on invoiced purchases. If you have received more VAT than you have been charged, you will owe HMRC the difference. If you have been charged more on your purchases than you have invoiced you will receive a refund. 

 

By keeping careful track of your sales and purchases you have flexibility to defer some of your sales invoices to the following quarter to help manage your cashflow. If you make more purchases the following quarter, this could help to reduce the amount of VAT you pay. 

 

The cash accounting VAT scheme allows you to calculate VAT when sales invoices are paid to you and when you have paid purchase invoices. The quarterly VAT you pay is then based on when money has been received and spent rather than when invoices have been issued and arrived. You don’t have to let HMRC know if you use this approach but you must be consistent. The main benefit is that, if your customer is slow to pay or doesn’t pay you at all, the VAT on that amount won’t be included in your return. 

 

You can file a VAT return just once a year, rather than quarterly. You will need to apply to HMRC to do this and while you reduce your annual VAT returns you will pay regular VAT instalments in advance. This can help small businesses by reducing paperwork and, because the payments are known in advance, they can be spread throughout the year. 

 

The amount of VAT you pay will be based on an estimate if you have registered for the first time or on your previous year’s VAT return. You can pay in three or nine instalments and then the outstanding balance at the end of the year when you submit your VAT return. If you have paid too much VAT you will have to apply for a refund once you have submitted your VAT return. 

 

This approach allows you to charge VAT at the correct rate for your business and you will pay the VAT charged on your purchases yourself. The difference is in how you work out how much VAT to pay to HMRC. According to your total taxable turnover for the year you simply apply a fixed rate defined by HMRC. The flat rate scheme helps small businesses because the fixed rates are lower than standard VAT at 20%. However, VAT payments can’t be claimed unless a capital asset costing over £2,000 including VAT is purchased. 

 

You have to apply to use the flat rate VAT scheme and if you choose it in your first year of VAT registration you are eligible for a 1% discount on your flat rate. 

 

With the VAT threshold currently frozen following the 2022 Autumn Statement you could find yourself approaching the VAT threshold sooner than you expected.