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The following simple guide is intended as an introduction to the tax for limited company contractors and other small businesses. If you’re an existing PayStream client and are looking for more detailed advice and guidance, please contact your dedicated accounts team.
A business usually a company, partnership or sole trader registered for VAT with HM Revenue & Customs (HMRC).
Where the supply, primarily of services, takes place. If it is outside the UK, it is likely to be outside the scope of VAT.
The taxable supply is being made as part of a commercial or business activity. This operates to exclude private or non-business transactions.
Likely to be of interest to SMEs, ‘mixed’ or ‘multiple’ supplies occur when a mixture of goods and services is supplied whose components are charged at different VAT rates.
Value Added Tax, or VAT, is in effect a business sales tax. It was introduced in the UK in 1973 when the country joined the then European Economic Community. It is levied by registered traders (or “taxable persons”) and is administered by HMRC.
It is charged by registered, ‘taxable’ persons on the supply of goods and services to other businesses and general consumers.
A business will charge what is called ‘output tax’ on the goods or services it supplies to customers. It can deduct any VAT it has suffered on goods or services supplied to it. This is called ‘input tax’. The net amount of VAT is paid over to HMRC. If the input tax exceeds the output tax, a VAT repayment to the business can occur.
This is effectively the consumer of the goods or services supplied although it is accounted for by the registered trader.
Whether VAT needs to be charged will depend upon the answers to a number of key questions:
1. Whether the supply is a business activity by a taxable person – someone or an entity like a limited company which has registered for VAT
2. Where the supply of goods or services takes place. There are complex rules which need to be carefully examined
3. Whether the supply is one in the furtherance of business
4. Whether the supply is exempt or outside the scope of VAT
As a business if your taxable turnover has exceeded £85k in the last 12 months, or if you consider that it will exceed £85k in the next 30 days then it must be registered for VAT.
HMRC can issue penalties for late registration based on a percentage of the VAT unpaid.
A business may voluntarily register for VAT even if its taxable supplies are below the registration threshold. This enables input tax to be claimed on the business goods and services which it purchases.
The UK VAT rates vary and depend on the type of supplies of goods and services provided.
Currently the Standard Rate is 20% and applies to most everyday taxable supplies. There is a Reduced Rate of 5% on a limited number of supplies like home energy whilst a Zero (0%) rate applies to goods like books.
Some goods and supplies qualify as exempt from VAT – financial and insurance services for example.
Finally, if the goods or services are supplied outside the UK they are regarded as being outside the scope of VAT.
Certain temporary VAT rate reductions were put in place by the UK government in 2020 and 2021 to support businesses during the COVID-19 pandemic.
There are a number of schemes available to different types of businesses. Some apply to businesses in specific sectors such as motor dealers, and the retail industry.
Other schemes are designed for smaller businesses and aimed at trying to reduce the administrative burden of managing the standard VAT obligations. They include the Flat Rate VAT Accounting Scheme.
Care needs to be taken on choosing the right one for your business.
For limited company contractors and other businesses working in the construction industry new VAT rules came into force on 1 March 2021.
They mean that VAT registered construction businesses who supply or receive construction and building services that fall under the Construction Industry Scheme (CIS) now have to apply a system called the ‘domestic reverse charge’.
Under these new rules the commercial customer (contractor) will be responsible for the VAT due to HMRC instead of the supplier (the subcontractor).
If you are likely to be affected by these new rules you should try to ensure that you understand how they work. Individual subcontractors and limited company contractors working under CIS should consult their accountant for further advice if they are at all uncertain as to the impact of these changes.
A multiple supply (also known as a combined supply) involves the supply of a number of independent goods or services bundled together for a single price. The supplies may or may not be liable to the same VAT rate, but each individual liability has to be identified and accounted for as appropriate.
The treatment, therefore, is significantly different depending on whether a transaction is found to be a single or multiple supply.
Although unlikely to affect many contractors, small businesses may find themselves in a position where an analysis of these supplies is needed to get the treatment right. In many cases it is safer to seek professional advice rather than risk making a costly error.
For VAT purposes, the place of supply of a service is the place where that service is treated as being supplied. This is the place where it is liable to VAT (if any).
If it’s in the UK it is subject to UK VAT. If the supply is in an EU member state or another country, it is said to be ‘outside the scope’ of UK VAT.
If your business belongs in the UK and the place of supply of your service is in the UK you must charge UK VAT regardless of where your customer belongs. If the place of supply of your services is outside the UK, you or your customer may be liable for any VAT or equivalent tax due to the taxation authorities of that country.
It is important to establish the exact nature of the service being supplied and to whom. In some circumstances HMRC’s rules in this area will depend upon whether the service is business to business or business to consumer. Again, this is quite a complex area so please seek advice if you are uncertain whether your supply of services to overseas customers is liable to UK VAT.
If, as a small business, you have chosen to use the Flat Rate VAT Scheme (FRS) you cannot normally claim back the VAT you spend on capital assets, bought for your business. This is already taken into account in the flat rate percentage used for your type of business.
However, you can claim the VAT back on certain business asset purchases where the VAT inclusive purchase price exceeds £2000. This may be something like a van or a computer for example. Special rules apply to these reclaims and they are handled outside the normal FRS process.
Contractors and other businesses not using the FRS can reclaim VAT on the purchase of business assets but should also remember that they are required to account for output tax at the appropriate rate on the subsequent sale of those assets.
HMRC publish a whole range of VAT Leaflets outlining both their day-to-day guidance on VAT and the more technical notes for complex aspects of the tax. You can look up these aids on the GOV.UK website.
As a PayStream client you also have access to a wealth of help and guidance from your dedicated accounts team who are experienced in handling VAT matters.
