Have a Start-Up? Here's What You Need to Know About VAT

Getting a start-up off the ground can and should be an exciting period. You know you have a great product, you’ve put into place financing, and you have a solid business plan. In some cases, your creativity may be set loose as you finally realize your dreams. As your new enterprise takes off and becomes successful it can be easy to overlook areas that are rather more mundane, but equally important. Operating a business comes with a certain amount of government red tape, and responsibilities. One of which is to pay VAT when it is due.

The tax year from 2021 to 2022 saw the UK government receive over 157 billion GBP in VAT receipts. A significant rise from the previous tax period which was impacted by the pandemic.The UK government doesn’t overlook VAT liabilities, and as a small business owner, you will have to understand when you need to register for this tax, and what exactly your responsibilities are.

What is VAT, and how is it levied on goods?

While some countries have zero income tax for their inhabitants, nearly everywhere has some form of tax in place. For instance, Jersey has no inheritance tax, but goods and services are taxed.There are direct taxes that are aimed at areas such as income, and there are indirect taxes. Some of these are called consumption taxes and are based on consumable goods and services. VAT is classed as a consumption tax and is an abbreviation of value-added tax.

The phrase value-added tax refers to the fact that the tax is applied to goods at every point where value is added. So, VAT is added by the supplier of raw materials when selling to a manufacturer who in turn adds VAT when selling the finished product to a retailer. Finally, the retailer adds VAT which is paid by the consumer. This can seem complicated to the uninitiated, but an online VAT calculator can make it easy to understand how much tax is being levied on a particular service.

Is VAT applicable in every country?

There are at least 179 countries that add VAT to various services and goods. Every country in Europe does so as well as throughout Africa and in many South American countries. There are exceptions, of course, Bermuda does not levy VAT on any goods, but the most notable exception is the US which also has no value-added tax. However, any business in the US that is planning to sell overseas, especially in the European Union or the United Kingdom, will need an understanding of the VAT system. 

When will you need to start paying VAT?

So, your start-up has exceeded all expectations and is performing well. Your turnover is steadily rising each month, and you’ve become aware that you may be reaching the VAT threshold.One of the reasons SMEs struggle to stay in business is a lack of understanding of finance, invoicing, and tax. Small enterprises are less likely to have a dedicated finance department dealing with tax concerns than a bigger more established business would.

Many entrepreneurs are highly creative, talented, and focused on their products, but have little knowledge when it comes to legalities and tax issues. Without proper accounting, it can be easy to fall foul of the HMRC.The current threshold for VAT in the UK is £85,000. If your turnover reaches or exceeds this in 12 months then you will need to become VAT registered. Also, if at any point your VAT taxable revenue is likely to breach the threshold in the upcoming 30 days, you will have to register. This is compulsory and must not be avoided.

Should you voluntarily register for VAT?

Some businesses voluntarily register for VAT, and there are some advantages to this. One is that having a VAT number and being registered can make your start-up look bigger and more established than it actually is. As far as start-ups are concerned, registering for VAT before you need to can be beneficial.

Start-ups cost money to launch. It is estimated that in the UK a start-up costs around £5,000 to get off the ground followed by perhaps another £20,000 in the first year. Registering means that you can claim back VAT on services your business used in the 6 months prior to registration, and on goods purchased up to 4 years before. There are conditions to be met here, but financially, voluntary VAT registration can be beneficial. Your customers will now be in a position to reclaim VAT if they are registered.

One downside though is that if your customers are not VAT registered your goods may no longer be competitively priced. And once you register you will have to submit tax returns, keep accounts for at least 6 years, and have more paperwork and red tape to contend with.

What areas and goods are VAT exempt?

Depending on which country you are based in, certain goods and services may be exempt from VAT. In the UK, they include the following areas: 

•Education & training

• Insurance

• Finance & credit

• Leasing of commercial buildings

• Charitable fundraising events

Understanding VAT and exemptions have become one of the biggest challenges for small business owners today with Brexit causing much confusion. But, if your business supplies VAT-exempt services or goods then your start-up will also be tax-exempt. This means that you cannot register, and you cannot claim back any VAT from purchases.

What are the risks of avoiding paying VAT?

Over 600 individuals were convicted in the UK in 2019 for tax evasion crimes. The most famous tax cheats would have to include Al Capone whose many other crimes went unpunished. But, not paying taxes was his downfall.In the UK, if you fail to pay your taxes you can face up to 7 years in prison, and an unlimited fine. VAT evasion is treated no less seriously. Small business owners need to understand their responsibilities or face serious consequences.If you evade or defraud your VAT returns you could face a £20,000 fine and six months in prison if you go to the magistrate's court. If the case goes to the Crown Court then you could face the same penalties for general tax evasion mentioned above. 

Are there any ways you can offset your VAT?

The VAT you have charged on goods and services must be passed on to HM Revenue & Customs. While you cannot offset your VAT, you can claim some back. If you purchased goods and services that were for your business then you can claim the VAT back. But, only if they are exclusively used in your business. For instance, you could claim the VAT back spent on fuel if it was all used on business journeys. If some were used for personal use then you cannot claim that portion back. This is where it can get complicated reclaiming VAT.

Summary

Start-ups can benefit from registering for VAT and reclaiming money previously spent on business-related goods. But, even if you choose not to register early, as soon as you reach the VAT threshold, registration becomes compulsory. VAT can become complicated and many small businesses will employ the services of an accountant. Yet, it is worth having a basic understanding of how VAT works when you launch your start-up so you are prepared for the moment you need to register.