VAT - An Essential guide for Small Businesses

It is important to track turnover carefully as when a business exceeds the VAT threshold it must register for VAT.

1) When to register for VAT
A business should register for VAT when turnover for the last 12 calendar months (not accounting year) exceeds £70,000. Turnover is defined as sales before tax. A business should also register if turnover is likely to exceed £70,000 in the next 30 days or if a VAT registered business is taken over as a going concern. If a business makes significant VAT inclusive purchases and sales to VAT registered customers, it may be beneficial to register for VAT on a voluntary basis.   

2) Disadvantages of registering

• Compliance: VAT returns must be submitted on-line on a quarterly basis one month after the quarter end. It is therefore imperative that up to date records are maintained to meet the filing deadlines.
• If a business sells mainly to consumers, then registering for VAT means passing on VAT by way of increased prices or reducing margins by absorbing the VAT. I have a client who recently registered for VAT as the business turnover reached the VAT threshold. The business is business to consumer and due to the economic downturn the owner decided not to pass all of the VAT increase on to customers and therfore for the business to absorb most of the VAT.
• Keeping up with changes in VAT legislation; VAT rates have changed so it is important to check regularly to ensure that you're using the correct rates. It is important to ensure that the business accounting software can cope with the different rates of VAT.
• It is important to be aware that VAT cannot be claimed on all items of expenditure and that depending on the nature of the supply, VAT rates can vary. For example, VAT cannot be re-claimed on business entertainment although VAT on staff entertainment may be re-claimed.
• Penalties for late filing. Late filing is taken seriously and there are various penalties for failure to meet deadlines and for filing inaccurate returns. 

3) Advantages of registering

• It may be beneficial to register for VAT where expenditure is VAT inclusive and sales are business to business, therefore, where VAT is a pass-through. I have a client that registered for VAT on a voluntary basis as it was beneficial to the business to recover VAT on significant start up/capital expenditure costs. The VAT refunds were hugely beneficial to the cash flow of the business.  

4) Mechanics of registering
VAT returns must be filed on line with HM Revenue & Customs.

5) Tips

• Register as soon turnover reaches the threshold. Failure to do so will result in a penalty and a charge for the VAT that should have been declared.
• VAT can be re-claimed on supplies three years pre-registration (if the business still has the goods) and services provided six months pre-registration. 
• There are a number of schemes to help small businesses with VAT. For example, the flat rate scheme is an annual VAT scheme which aims to simplify accounting for VAT.

6) When to De-register

• If the circumstances of the business change it may be necessary to de-register for VAT.

VAT is a complicated tax. If you would like any advice on this area or any other areas of accounting or tax, please contact me on 07834988638 or mail@sjhaccounting.co.uk, www.sjhaccounting.co.uk. Sarah Hamilton takes every care to ensure that the material is up to date and accurate. However, no responsibility for loss to any person acting or refraining from acting can be accepted by Sarah Hamilton. You should always ask your accountant to give you specific advice which is tailored to your personal and business circumstances.

Business Structure: Limited Company v Sole Trader

There are a number of factors to consider when deciding whether to set up a business as a limited company or a Sole-Trader.

1) Record keeping
A company is required to:

• Keep accounting records and to produce audited accounts (if turnover > £5.6m). 
• File accounts and an Annual Return with Companies House. This information is in the public domain.
• Keep Statutory Books.

A sole-trader is required to:

• Prepare annual accounts for Self-Assessment tax return purposes. Annual accounts are not required by law.

Limited companies have a greater administrative burden. Professional fees (accountancy & legal) will be larger for a limited company.
It is more difficult to wind up a limited company than a sole trader business if a new venture does not work out.
Limited company information is in the public domain whereas as a sole trader information is private.

2) Payment of tax

A company is taxed in the following way:

• Tax is payable on director's remuneration via PAYE on 19th of the following month.
• Tax is paid on dividends under the Self-Assessment rules. Dividends are effectively not taxed whilst in the basic rate band. Once in the higher rate tax band dividends are effectively taxed at 25%. There is no NI on dividends.
• The company pays Employer's NI at 12.8% on a salary of over approx. £6k.
• Corporation tax is payable 9 months after the year end. Profits less than £300,000 are currently taxed at 21%.

A sole-trader is taxed in the following way:

• Tax is paid in instalments under Self-Assessment on 31st January in the tax year and 31st July of the following tax year.

For the majority of small companies, the most tax efficient way to extract profit from the business is to take a salary up to your personal allowance and to dividend the excess. However, dividend vouchers must be drawn up and minutes kept to document the dividends. Also, a dividend cannot be paid if the company doesn't have retained earnings.


3) Losses

A company can only carry forward tax losses against future profits of the limited company business. Limited company losses cannot be offset against personal income. 

A sole-trader can use losses against other income in the year or carried back to prior years.  

A sole-trader has greater flexibility in loss utilisation. Most businesses are loss making in the early years. If you leave a highly paid job to start up on a self-employed basis it is possible to offset losses against trading income. Losses can also be offset against other income, including dividends, savings interest or rental income.


4)National Insurance

A company is liable to employer's and employees' national insurance on director's salaries and bonuses. The NI charge is greater than that paid by a sole trader.

A sole-trader is liable to Class 2 NI of £2.40 per week and Class 4 dependent on the level of profits. 

The NI charge of a limited company is greater than a sole trader.


5)Prestige
An unincorporated business may not carry the same prestige as an Incorporation.

6) Tax on profits 
A company is liable to Corporation tax of 21% for profits up to £300,000 (2010/2011).

A sole-trader is liable to Income tax at 40% of taxable income over £37,000 and 50% over £150,000 (2010/11).

Therefore the choice of sole-trader versus limited company structure is not clear cut particularly if profits are less than £50k. However, when profits reach ~£100k, it may be beneficial to set up a Limited Company. (Limited Company tax approx. £10k less than Sole-Trader). 

If you would like any advice in this area or any other areas of accounting or tax, please contact me on 07834988638 or mail@sjhaccounting.co.uk, www.sjhaccounting.co.uk. Sarah Hamilton takes every. care in preparing material to ensure that the content is accurate and up to date.  However, no responsibility for loss to any person acting or refraining from acting as a result of this material can be accepted by Sarah Hamilton. You should always ask your accountant to give you specific advice which is tailored to your personal and business circumstances.