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Value Added Tax (VAT)

Administered by HMRC, this is a complex tax imposed on businesses that contractors may need to consider – depending upon their taxable turnovers. VAT is charged on the majority of items and services that you buy and therefore as part of running your business, you will pay VAT on raw materials, electricity, phone calls and so on. If you are VAT registered you need to charge VAT on the service you are providing to your clients. You also need to ensure you maintain accurate records and make VAT payments to HMRC.

There are three main VAT rates: zero (things like food and children’s clothes), 5% (for example on home energy) and 20% - 20% is the one used on the majority of items. If you are unsure of the correct rate you can find details on the gov.uk website.

So if you are VAT registered, which you should be if your annual income is more than £83,000, you need to add 20% (2016 rate) on top of whatever services you sell. Most PSCs apply for VAT registration at the time of forming the company to make the most of their cash flow and reduce startup costs.

Types of VAT

Output VAT

This is the amount of VAT a company adds to the price of its goods and services.

Input VAT

This is the amount of VAT tax paid on purchases made by the company.

You need to submit a VAT return every quarter showing all your VAT outputs and inputs. If outputs exceed the inputs, you will be need to pay the difference to HMRC. In case inputs exceed outputs, your company can claim a refund.

VAT schemes

Contractors have the option of operating their tax returns to HMRC via any of the three schemes mentioned below, in addition to the standard VAT scheme:

Cash accounting

To be eligible for this scheme, your VAT taxable turnover per annum must be £1.35 million or less. Under this scheme, you can pay VAT on your sales when your customers pay you and reclaim VAT on your purchases when you have paid your supplier.

Flat rate VAT scheme

Under this scheme, you can pay a fixed rate of VAT to HMRC and keep the difference between what you charge your customers and what you pay to HMRC. To join the flat rate scheme, your annual VAT turnover must be less than £150,000.

Annual accounting

If you opt for this option, you can make VAT payments in advance based on your last tax return. This scheme will not suit businesses which regularly reclaim VAT because you’ll only be able to get one refund a year. You can join this scheme if your estimated VAT taxable turnover per annum is £1.35 million or less.

Register for VAT

If you think you are likely to reach the VAT threshold amount of £83,000 or more during any 12 month period (this is the 2016/17 threshold), you must register your company for VAT. This can be done online or else your accountant can arrange this for you and must be done within 30 days of achieving the threshold. You can be fined if you delay for too long after achieving the threshold.

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