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How Does VAT Work for Small Businesses?

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Last editedNov 20202 min read

Many small businesses are unfamiliar with how VAT works and aren’t sure whether it applies to them. Even if you’re reasonably sure that you don’t need to register for VAT, it’s important to find out for sure. If you meet the small business VAT threshold, failing to register could lead to serious penalties, including substantial monetary fines. How does VAT work for small businesses? Do small businesses pay VAT? Find out the answers to these questions, and more, with our comprehensive guide to VAT explained for small businesses.

What is VAT?

VAT stands for Value Added Tax, a consumption tax that’s applied to the sale of goods and services in the UK. In other words, VAT represents a price-bump on most purchases for the consumer. Currently, the rate of VAT is set at 20%. So, if the price of the product pre-VAT is £25, then the price post-VAT is £30 ((25 x 0.2) + 25 = 30). Technically, VAT isn’t a tax on businesses, but a tax on customers, and while businesses pay VAT to HMRC, the cost has been covered by the consumer. This is why VAT is referred to as an indirect tax. So, how does VAT work for small businesses?

What is the small business VAT threshold?

Do small businesses pay VAT? Well, some do, and some don’t. Whether or not your business pays VAT isn’t so much to do with the size of your business as it is to do with your annual turnover. This is referred to as the VAT threshold. In the UK, the VAT threshold is £85,000. Put simply, this means that if your business’s annual turnover is £85,000 or above, you will need to register for and start paying VAT.

Does VAT apply to sole traders as well?

Yes, if your sole trade business earns more than the VAT threshold of £85,000, then you will need to register for VAT. The fact that you’re a sole trader – or even a partnership – doesn’t provide you with any exemption from VAT. However, if your company’s annual turnover falls below the small business VAT threshold, you won’t need to register for VAT, although you can do so if you want.

Should I register for VAT even if I don’t have to?

Even if your business earns less than the small business VAT threshold, you can still register for VAT. If you do choose to register for VAT, you’ll need to send VAT returns to the HMRC four times a year and increase the amount that you charge for your products. As such, it might sound like an unnecessary amount of hassle to deal with, when you could simply wait until you’re legally obligated.

However, there are a couple of reasons why it might make sense to register for VAT voluntarily. Firstly, it gives you an opportunity to recover the VAT that you incurred in start-up costs. So, if you spend a considerable amount of money on new equipment and supplies when starting your business, you may be able to reclaim a portion of that cost back through VAT, giving your business a healthier cash flow.

Furthermore, being a VAT-registered business will lend your company an air of authority and permanence that many clients look for when doing business. Plus, registering for VAT means that potential clients won’t know your annual turnover, whereas if you’re not registered for VAT, they’ll know for sure that you’re making less than £85,000. While in many cases, this won’t matter, some clients prefer to do business with more established brands. As a result, registering for VAT could be a good idea.

How do I complete my small business VAT registration?

Registering for VAT is simple. All you need to do is complete your small business VAT registration online and you’re good to go. Once you’re registered, you’ll be able to fill in your VAT returns, although if you’d prefer, you can appoint an accountant/agent to deal with HMRC on your behalf.

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