Understanding VAT

Value Added Tax (VAT) can be a minefield - complex schemes, evolving penalty rules, digital filing mandates, and HMRC scrutiny can all seem quite scary. To help you understand the UK VAT system, keep your business compliant and avoid costly surprises, we've put together this essential guide.

Understanding VAT schemes

VAT doesn't just affect what you collect, it also shapes how and when you report it. Here are the key VAT accounting schemes in the UK:

Standard VAT Accounting Scheme

The default method for VAT registered businesses. In this scenario, you are required to charge VAT on sales, reclaim VAT on purchases and submit quarterly returns using MTD compatible software. Claims and payments are invoice-based, not payment-based.

VAT Flat Rate Scheme (FRS)

Simplifies VAT by applying a sector-specific flat percentage to your turnover. You keep the difference between what you collect and what you pay, but typically your business can't reclaim VAT on your purchases, except on some assets over £2,000. You can only join this scheme if your turnover is under £150,000 (excl. VAT).

VAT Cash Accounting Scheme

VAT is accounted for based on payments received by your customers and when you pay your suppliers, not invoice dates. This can help manage your cash flow. This scheme is available if you have a VAT taxable turnover of £1.35 million or less.

VAT Annual Accounting Scheme

Submit one VAT return per year and make advance VAT payments based on your last VAT return or an estimation of your likely VAT bill if you have recently become VAT registered. While this is a good system for simplifying your admin, it means you can only reclaim VAT on purchases once a year. As with the cash accounting scheme, your VAT taxable turnover must be £1.35 million or less.

Other options: Retail and Margin Schemes

If you are a retailer, HMRC has simplified the process for calculating your VAT, with three standard VAT retail schemes: Point of Sale, Apportionment or Direct Calculation schemes. You can choose one of these schemes and use it together with the Cash Accounting Scheme or the Annual Accounting Scheme.

You can use the VAT Margin scheme if you sell antiques, works of art, collectors' items or second-hand goods.  You pay VAT at the rate of 16.67% on the difference between the price you paid for an item and the price you sold it for.

VAT registration and record-keeping

Threshold: You must register if your taxable turnover exceeds £90,000 in any rolling 12-month period.
Register early: Delaying could expose you to registration penalties. Penalty rates vary:

• Registration late by up to 9 months: 5% of VAT owed
• 9 - 18 months late: 10% of VAT owed
• Over 18 months late: 15% of VAT owed.
• There is a minimum penalty of £50.

Record-keeping essentials:

• It is mandatory to use Making Tax Digital (MTD) compatible software to log all your VAT related income and expenditure
• Your records must include: all transactions, copies of all your invoices and receipts, debit or credit notes, and any goods you use from your stock for private use.
• Upload your invoices, receipts, and track payments
• Retain documents for HMRC inspection for at least six years.

Handling VAT inspections and disputes

Be prepared. HMRC can audit your VAT accounts, especially if anomalies surface. They may contact you to arrange a compliance visit. To help reduce your risk of an inspection:

• Keep organised digital records in MTD-compliant software
• Respond promptly to queries, as delays can escalate issues
• For disputes, know your rights (e.g. objection, appeal) and consider professional advice if issues become complex or repeated

Late payments & penalties

From 1 April 2025, late VAT payment penalties have become significantly stricter:

• 15 days overdue: first penalty of 3% of the VAT amount is due
• 30 days overdue: the second penalty of 3% of the VAT amount is now also due.
• 31 days onward: daily penalties at 10% per year of outstanding VAT are due

Business owners and directors must prioritise submitting their VAT returns and paying their VAT bills promptly to avoid incurring significant penalties, which could be detrimental to the business.

Quick tips for keeping VAT under control

Conclusion

The VAT rules can be a minefield, but they don't have to trip you up. By understanding the right scheme for your business, staying compliant with MTD, monitoring deadlines, and staying abreast of VAT policy changes, you can master VAT management in your business.

How can DWilkinson&Company help?

If you're thinking about becoming VAT registered or have any questions about the different VAT schemes or complying with the VAT rules, please get in touch at 0113 320 0001 or email office@dwco.co.uk.