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As a contractor, you could find that registering for VAT or Value Added Tax will save you a significant amount of money, especially if you are operating through your limited company. Umbrella contractors can benefit from being VAT registered too, but to a lesser extent although your umbrella company will usually take care of your VAT payments for you. For more information about VAT and how it affects contractors we have created this easy to read guide which covers the basics of VAT for contractors.
VAT is a sales tax that is charged on top of the price of most products and services. Some products and services are exempt for VAT, for example if you are a Locum Doctor you are usually not required to charge VAT on your services, but most other contractors who are VAT registered will charge the standard rate of 20%.
If your limited company has an income that exceeds or is expected to exceed the VAT a threshold, which is currently £85,000 annually before tax then you must register for VAT. If your company earns over the VAT threshold and you do not register, you run the risk of being fined by HM Revenue and Customs (HMRC). It is important to be aware that the VAT threshold changes and so we recommend that you check the threshold each year on the HMRC website to see whether you are over or under the amount. Once you are VAT registered you must charge VAT on your services or any products that you sell.
VAT registration can be completed online via the HMRC website. If you are a limited company director you will need your Companies House Registration Number and your Unique Taxpayer Reference when registering. For more information about becoming VAT registered you may want to read our complete guide to registering for VAT.
If your limited company does not meet the VAT threshold then you are not required to register for VAT. However, there are a number of companies that voluntarily register because it can be advantageous for their business. Being VAT registered will make your business look larger than it actually is which may impress companies when you are looking for your next contract role. It is also worth noting that some businesses stipulate that they will only work with contractors who are VAT registered and working through their own limited company. There are of course some downsides to being VAT registered, the main one being that it could make your prices less competitive because you are required to charge VAT on top of the usual price of your goods or services. For example, if you are invoicing a company for £1,000 you will need to charge VAT in addition to that amount making the total £1,200. The alternative is reducing your costs to encompass the additional VAT charge, but that would mean less money in your pocket. If you are unsure whether registering for VAT is the right decision then it is probably best to discuss this with your accountant.
You must start charging VAT on your goods and services the day that you register with HMRC, not that day that you receive your VAT certificate – which can take up to 30 days to arrive. While you are waiting for your VAT certificate you will need to include your sale amount and your VAT amount as a total figure when raising an invoice. Once you receive your VAT number you can state this on your invoices and put the sale amount and VAT amount as two separate figures and then re-issue the invoice to your clients. This means that neither party misses out, as you are able to charge for the VAT amount and your client will have the opportunity to claim the VAT back.
If you are registered for VAT, you are required to complete and submit a VAT return to HMRC every quarter. The VAT return will include the total amount that you have charged in VAT for the period known as your output tax and the amount of VAT that you have incurred on company purchases which is known as your input tax. Once the return is submitted to HMRC they will review your information and if your output tax exceeds your input tax you must pay the difference, but if your input tax exceeds your output tax then your company is entitled to a refund of the difference. You may also be able to claim back VAT on costs that you incurred before you registered for VAT provided that you have the correct records and meet all the requirements, you may want to speak to your accountant for more information.
Companies that are VAT registered are able to claim back VAT that they have incurred on purchases for their business as long as the total amount of VAT incurred (input tax) does not exceed the total amount charged in VAT (output tax). Being VAT registered will make your company appear large and gives it a grander and more professional image compared to non VAT registered companies. When looking for new contracts you will find that some businesses will specify that they will only engage contractors who are working through a limited company and who are VAT registered. Just as you are able to claim back the VAT you have incurred, your clients will also have the opportunity to claim back the VAT on your invoices and so won’t be put off engaging you in a contract because of the extra VAT charge.
The information above is based on the standard VAT scheme. However, the introduction Flat Rate VAT Scheme has changed the nature of VAT for many contractors. scheme was introduced by the government to simplify VAT for small businesses and is especially beneficial to those that provide a service and therefore do not have a large amount of company expenses – namely contractors. You can find more information in our guide to the Flat Rate VAT Scheme.
Those who are part of the Flat Rate VAT Scheme charge VAT on their invoices at the standard rate of 20%, but are only required to pay back HMRC at a lower rate. Previously, under the Flat Rate VAT Scheme, the amount you paid was determined by the type of service you provide. However, contractors under the new ‘limited cost trader’ category will be subject to the 16.5% rate (as of April 2017).
A limited cost trader is defined as one whose gross expenditure on relevant goods is either:
• less than 2 % of their VAT inclusive turnover or
• greater than 2% but less than £1000 per annum You can check to see whether you meet the criteria on HMRC’s website.
We hope that this guide has helped to shed some light on the basics of VAT, but if you have any questions or would like more information please contact a member of our new business team on 01253 362062.