The rules for VAT registration are the same for self-employed people as well as limited companies.
The basic rule is if your sales is going to be more than £82,000 in the next 12 months you should register for VAT. You shouldn’t wait until you pass the £82,000 if your monthly run rate is higher than £6,833 i.e. if right from the beginning, you think you will go above annual £82,000, you should register straight away.
You can still register for VAT even if your sales don’t go above £82,000. The reason why you may do this is to appear to customers bigger than you are.
Four different types of ways to account for VAT
The first thing you have to do when you become VAT registered is start charging VAT on your sales invoices i.e. 20% on top of your normal fee/price.
The basic rule is if your sales is going to be more than £82,000 in the next 12 months you should register for VAT. You shouldn’t wait until you pass the £82,000 if your monthly run rate is higher than £6,833 i.e. if right from the beginning, you think you will go above annual £82,000, you should register straight away.So your invoice looks like this on a fee that you are charging to a customer of £1,000.
The customer then pays you the £1,200.
You then have to make sure that you get VAT receipts for all your business expenditure so that you can claim the VAT back (only on option 1 and 2, see below).
However, if becoming VAT registered isn’t complicated enough, you are then faced with 4 options of how to account for VAT.
Option 1 – VAT on invoices
You declare to HMRC all the VAT on your invoices in the quarter minus all the VAT on your purchase invoices and expenses.
This is the most common way of accounting for VAT.
Option 2 – VAT on cash
You declare to HMRC all the VAT on your sales receipts in the quarter minus all the VAT on your purchase invoices and expenses.
The advantage of this is that you are only ever paying VAT over to HMRC that you have received from your customer. In option 1, you could pay VAT over to HMRC on an invoice that hasn’t been paid yet.
The disadvantage of this is that makes the bookkeeping more complicated.
Option 3 – VAT on invoices using the flat rate scheme
The flat rate scheme is for businesses of less than £150,000 turnover (sales).
Rather than option 1, you are assigned by HMRC a specific flat rate %. So for example 12%. The % is based on your type of business, you can find the current list here:
You then add up all your sales invoices and INCLUDE the VAT – i.e. you add up the GROSS amount of your invoices (the NET + the VAT = the GROSS) and then you multiply this amount by the flat rate %.
Sounds like a no brainer since your flat rate % will be lower than %. However, you COMPLETELY IGNORE the VAT on your expenditure.
(I say COMPLETELY IGNORE, there is a special rule that means you can still claim the VAT on ‘capital costs’ over £2,000 even on the flat rate scheme)
Option 4 – VAT on invoices cash the flat rate scheme
This is the same principle as option 3, it just means you add up the sales receipts (which will include the VAT) and apply the flat rate %.
The flat rate scheme was introduced by HMRC to make it easier for smaller businesses to account for VAT, it was not meant to save you VAT.
However, for certain businesses you will save VAT and the difference between option 1 and 2 and option 3 and 4 could be significant.
Generally speaking, if you don’t have a huge amount of VATable expenditure then the flat rate scheme could save you VAT especially if your flat rate % for your industry is lower i.e. around the 12% mark. Another incentive for you to use the flat rate scheme is that you get a 1% discount on the industry flat rate in the first year AND accountants tend to charge less for flat rate VAT returns since they are much more straightforward.
I regularly calculate the difference between going on the flat rate scheme or using the more traditional method of option 1 and 2. If you would like me to do this for you, email me at firstname.lastname@example.org . The difference could be an annual VAT saving of up to £3,000 per year.