VAT for SMEs

There are four main VAT schemes available to small and medium enterprises.

They are:

  • standard accounting scheme
  • cash accounting scheme
  • flat rate scheme (including limited cost business)
  • annual accounting scheme

Here is a brief look at each of the schemes, how they work, and when it may be beneficial to use them.

Standard accounting scheme

This is the default way of accounting for VAT. The VAT is accounted for at the point at which the invoice is raised, regardless of whether the monies are received or paid. Irrecoverable (bad) debts can only be recovered six months after the date the money is due, that is, if an invoice is ‘net 30 days’, then, in effect, seven months after the invoice date.

Standard accounting could, and did, cause cashflow problems for many SMEs. Because of this it is often advisable to recommend one of the ‘more cashflow friendly’ schemes as below.

Cash accounting scheme

This scheme allows the VAT to be accounted for at the point of payment or receipt. This not only reduces cashflow problems in that HMRC does not receive money until the SME does, it also means that there is no need to account for any irrecoverable debts. The money is not received, therefore the VAT is not declared.

A business can remain on this scheme until turnover exceeds £1,350,000. After this the business must use the standard accounting scheme from the beginning of the next tax period.

Further information can be found on the gov.uk website.

Flat rate scheme

The flat rate scheme is designed to make record keeping for small business easy. It is for businesses that are

  • VAT registered
  • Turnover of £150,000 (excluding VAT).
  • Turnover to include all standard, reduced, zero-rate and exempt supplies, but not capital items.
  • A set percentage is applied dependant on industry sector

Business can remain in the scheme whilst turnover (as above) is less than £230,000.

How it works

Invoices still need to be issued at the applicable rate for the goods, that is, standard, reduced or zero rate, and the VAT should still be shown separately. Copies of all invoices are still to be kept but the benefit is that accounting records can be reduced.

It is not suitable if the business receives repayments, has a lot of zero-rated and exempt sales or buys a large amount of standard rated items.

First year discount

If a business registers for the flat rate scheme at the same time as registering for VAT then it could be eligible for a first year discount. If however the business decides to join the flat rate scheme say eight months after registering for VAT then the business will only get the discount for four months. The benefit of researching the different VAT schemes prior to registration is plain to see.

Limited cost business

This applies a set percentage of 16.5% for businesses that meet the following criteria, regardless of industry sector.

  • Goods bought is less than 2% of the VAT inclusive turnover
  • Goods no more than £1,000 per annum fi the 2% is exceeded (£250 per quarter)

Every quarter check that the business still falls within the limited cost business rules by going online and using HMRC calculator.

To calculate the VAT due or repaid

A set percentage, determined by HMRC, is applied to the VAT inclusive total turnover. The total is the amount of VAT due to HMRC or to be refunded by HMRC. There are set percentages for each industry sector .

An example would be if a business had a quarterly turnover of £12,000 + VAT at 20% = £2,400, and the percentage as detailed on GOV.UK is 16.5%, then the VAT due would be £2,376.

The flat rate scheme can be used with either cash accounting scheme or with the standard accounting scheme.

Annual accounting scheme

This scheme is eligible for SMEs with expected or actual turnover of less than £1,350,000 (excluding exempt supplies) per annum. There is only one VAT return to submit in a year, but advance payments must be either

  • nine monthly payments of 10% (of estimated turnover or based on previous VAT returns) plus a tenth balancing payment due within two months of the twelve month period (as below)
  • three quarterly payments of 25% followed by a final balancing payment again due within two months of the twelve month period, as demonstrated below.

The final balancing payment allows all records to be updated and maximum amount of monies received, before payment has to be made to HMRC.

Conclusion

The above is but a brief outline of four of the more useful schemes that could benefit the SME. Further research will need to be done to see which, if any, suits the particular business, but it is hoped that the above may go some way to reducing the amount of work needed to be done.

There’s not long to go before finance professionals and businesses must change their processes for the introduction of Making Tax Digital for VAT (MTDfV).

AAT have created a special ebook and software review, which is now available to download.

Download the guide

Julie Hodgskin is a fellow member of AAT, runs a licensed accounting practice and is a technical materials author for CIPP.

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