VAT for self-employed workers:how it works ?

What is VAT?

VAT stands for value-added tax. It is a tax on consumption and is added to the price of nearly all goods and services provided in the UK. We say “nearly” because certain goods and services are exempt from VAT, including the provision of most financial services, funeral services, medical treatment and other health services and postal services.

VAT can be charged at three different rates, depending on the goods or services being provided. Most commonly, the standard rate of VAT applies, which is currently 20%. This is applied to most goods and services in the UK. The reduced rate of VAT, which is currently 5%, is applied to certain defined categories, including children’s car seats, home energy bills and mobility aids. The third VAT rate is the zero rate, which is, as its name suggests, charged at 0%. Goods such as cycle helmets, children’s clothing and footwear, books, sanitary protection products and most food and drink for human consumption all qualify for zero-rated VAT. It is important to remember that being zero-rated for VAT is not the same as being exempt from VAT.

A full list of the various categories of goods and services to which the standard, reduced, and zero rates of VAT apply can be found on the HMRC website.

Who charges VAT?

UK legislation requires all traders with a turnover above what is known as the “VAT threshold” to register for and charge VAT.

The VAT threshold in the UK is currently set at £85,000. This means that any business, including self-employed workers, that has a taxable turnover over this amount must register for VAT. If a business expects its taxable turnover to exceed £85,000 in the next thirty days, it also has an obligation to register for VAT.

Failure to register for VAT on time, i.e. exceeding the VAT threshold before registering for VAT, can lead to issues, as the VAT must be charged retrospectively from the date on which VAT registration should have taken place. This involves re-issuing invoices to include VAT. HMRC may also issue a financial penalty under certain circumstances. 

It is best, therefore, to anticipate your turnover and register for VAT on time.

If a business has an annual turnover of less than £85,000, it has no legal obligation to register for or charge VAT on its invoices. However, under certain circumstances, it may be in their interests to do so. Only VAT-registered businesses can reclaim the VAT they pay on goods and services they buy. If a business charges more input tax than it would claim output tax, it will make sense to register for VAT and reclaim the difference.

Let’s take an example. Ahmed is self-employed and makes his living producing and selling children’s clothes. To make the clothes, he buys bulk quantities of material and other sewing equipment, paying the standard rate VAT (20%) on these purchases. The clothes he goes on to sell to the consumer are sold with a reduced rate of VAT (5%). Because he is not registered for VAT, Ahmed is unable to claim back the difference between the input tax and the output tax. It may be in his interest to register for VAT.

Registration under the VAT threshold for self-employed workers should be considered carefully, on a case-by-case basis. Over the VAT threshold registration is compulsory, even for self-employed workers.

Registering for VAT

Most businesses and self-employed workers can register for VAT online. They do so through the HMRC website and create what is known as a “Government Gateway Account”. Businesses can also appoint a third party, such as an accountant, to do this on their behalf. 

Once registered, a business will be issued with a nine-digit VAT number, which must be included on all invoices and will be given confirmation of the date upon which they became VAT-registered, known as the “effective date of registration”. 

In a very small number of cases, VAT registration cannot be completed online and must be done by post. This is the case if the business is applying for an exception or if it intends to join the Agricultural Flat Rate Scheme.

Charging VAT

Once a business is VAT-registered, VAT at the appropriate rate must be included on all invoices issued after the effective date of registration.

In order to charge VAT, you need to calculate the VAT on the price of the good or service at the appropriate rate and include that on your invoice. Your invoice must show your VAT number, the client’s VAT number (if they have one), the total price excluding VAT, the amount of the VAT and the rate at which it is being charged.

Let’s take an example. Chloe is a self-employed furniture maker and has recently registered for VAT. She sells a table which costs £75. To calculate the VAT on the table, she should multiply £75 by 1.2 (standard rate VAT), which gives £15. The total price of the table to the customer is, therefore £90. Chloe’s invoice should indicate the cost of the table (£75), the cost of the VAT at 20% (£15) and the sale price of the table (£90).

In some cases, you may request that clients pay a deposit or make an advance payment to secure the future purchase of an item. In this case, the VAT is due on the date at which the VAT invoice is issued for that deposit or advance payment.

Prior to Brexit, a mechanism known as the “reverse-charge mechanism” applied to transactions between UK businesses and VAT-registered clients in other EU countries. This is no longer applicable, although the reverse-charge mechanism does still apply to transactions between Great Britain and Northern Ireland. For further information, consult the HMRC website.

VAT returns

All VAT-registered businesses, including self-employed workers, are obliged to file what are known as quarterly VAT Returns. A VAT Return is a document that sets out how much input VAT the business has charged and how much output VAT it has paid. The difference between the two amounts determines whether the business will receive a VAT repayment or whether it has a VAT bill to settle.

VAT Returns must be filed online, through the government’s Making Tax Digital platform.

The deadline for submitting VAT returns is one calendar month and seven days after the end of what is known as the “accounting period”, the three-month period covered by the return. The first accounting period begins from the effective date of registration for VAT.

You should note that if you owe HMRC money once your input and output VAT has been calculated, the deadline for paying this amount is the same as the deadline for filing the return. It is always best to anticipate this and factor how long your bank transfer may take into your planning.

Record keeping

As with anything relating to accounting, it is essential to keep meticulous VAT records. When it comes to recording how much VAT you have paid and how much you have charged, you need to keep documentary proof. Invoices are easy to file and archive, but you should also keep all receipts for VATable purchases, including transport, food and drink, office supplies and any other business expenses. 

In the event of a tax inspection, you will need to provide proof of all VAT payments, so it is best to be prepared and systematically record your VAT incomings and outgoings.

Conclusion

Self-employed workers often baulk at the idea of registering for and charging VAT. It can appear to be a complicated and time-consuming task. Moreover, tax regulations can change, as was the case during the coronavirus pandemic when the government allowed VAT-registered companies to defer their VAT payments. 

But keeping on top of VAT doesn’t need to be difficult. Registering for VAT can make good financial sense, even if you are turning over less than the VAT threshold! With Mooncard, you can streamline your business expenses and easily keep track of your input and output VAT.

Find out how a Mooncard corporate card can help you get to grips with VAT by booking a free demonstration.