There are many different VAT schemes available, depending on the size and type of business. In my training company, I quite often teach a little about VAT and am always surprised how many businesses don’t realise that there are different schemes to choose from.
Standard VAT Scheme
The scheme that everyone has heard of is the Standard VAT Scheme. The scheme is based on when the invoice is raised. So when you raise a sale invoice, it would automatically be included in the next VAT return. This is fine if you have customers that pay on time but if you struggle with slow-paying customers, then you might find you have cash flow issues, being on this scheme, as you will be paying HMRC well in advance to receiving payment.
Some businesses are guilty of putting through all of their expenses for VAT, whilst holding back from updating their sales invoices, before running their VAT return, to keep their VAT as low as possible. This should not be done, of course. Perhaps they should consider a different scheme – the VAT Cash Scheme.
VAT Cash Scheme
This scheme is based on when a business pays and receives money, rather than when the invoice is raised. This is a good scheme for businesses who have slow paying customers. The VAT return is based on a list of receipts and payments. So the business accounts for VAT on sales, only after receiving payment. This can ease the cash flow for many businesses. Any business with a turnover under.£1.35 million can join the scheme and must leave the scheme if the turnover reaches £1.6 million.
Please be aware that if a business changes VAT schemes, there will be accounting adjustments that will need to be made, in order to ensure that VAT is accounted for correctly. For example, if a business moves from the VAT standard scheme to the VAT cash scheme, outstanding customer and supplier balances will have already been accounted for in previous VAT returns and will need to be adjusted for in subsequent VAT returns. So if you intend moving schemes, please ensure that you get the necessary advice and help from your accountant first.
Flat RATE Scheme
This is another scheme that HMRC has provided for smaller businesses. The turnover threshold must be under £150,000 to join the scheme and if the turnover threshold reaches £230,000, the business must leave the scheme. How does it work? A more simplified calculation is used to determine the Vat liability. The flat rate scheme is based on the gross sales only, multiplied by the % set by HMRC for that type of business.
The link to the industry table on HMRC website is https://www.gov.uk/vat-flat-rate-scheme/how-much-you-pay. HMRC works out roughly what amount of vat would be claimed back by each type of business and reduces the vat % on the sale to compensate. Some businesses prefer to have a simplified way of calculating their vat return due to time constraints. This method would ensure that vat returns are completed on time, thus avoiding possible penalties. At the end of the year, however, a catch up on the bookkeeping would be required in order to produce the accounts, as the likelihood is that the purchases and the expenses may not be up to date, as they are not necessary for this type of vat return.
You can use the Flat Rate Scheme on either the Cash Accounting basis (based on when you receive payment) or the Standard Vat basis (based on when you raise the invoices). Some software, like Sage, will be able to account for Vat on this scheme. You may have to make the calculations separately and enter a journal on other software.
There are other types of Vat schemes apart from the schemes discussed. Some are for particular types of businesses – for example, the second hand car margin scheme which has rules specifically for second hand car salesmen. Always, ask your accountant’s advice when choosing a scheme. At least it is useful to know that there may be more than one scheme to choose from and understanding how these schemes work can help you to make an informed choice for your business.
VAT Frequencies
Another area that may be of interest is knowing your choice in when you report your vat returns. Many businesses opt for a quarterly vat return. But a business can also choose to have a monthly vat return or a yearly one. HMRC can insist that a business uses a monthly reporting frequency if the owner had previously had a business that went bankrupt, owing HMRC money. As some people seem to make a career out of running a business for a while, then bankrupting it and moving on to set up another one, HMRC make impose rules on such a business, insisting on a monthly vat return to have an up to date view of the business at all times. HMRC can also impose a bond before the business can begin trading too.
What about the yearly vat return? This is based on the previous year’s trading and the business is expected to pay a regular amount towards their final vat return. If the trade is significantly different to the previous year, the business can contact HMRC and adjust the payment scheme to fall more in line with the current trading year. When the yearly vat return is completed, the balance will be paid over to HMRC and then the process starts again.
Businesses can also ask HMRC to align their vat return reporting period in line with their financial year end. This makes it easier for the accountant to reconcile the vat account at the end of the year, whilst preparing the accounts. This can be done whilst registering for VAT.
VAT Schemes
There are many different VAT schemes available, depending on the size and type of business. In my training company, I sometimes teach a little about VAT and I am always surprised by how many businesses don’t realise that there are different schemes to choose from. Today, I am going to compare the Standard VAT Scheme and the Cash VAT Scheme.
Standard VAT Scheme
This is the scheme that is based on when the invoice is raised. So once the invoice is raised, it should be included in the next VAT return. The VAT return includes of a list of sales invoices and purchase invoices and expenses. This is fine if the customers pay on time but if the business struggles with slow-paying customers, then the business might find it has cash-flow issues, as it will be paying HMRC the VAT on the sale, well in advance to receiving the payment. Some businesses are guilty of putting through all of their expenses for VAT, whilst holding back from updating their sales invoices, before running their VAT return, then updating the sales invoices after the VAT return has been submitted. This should not be done, of course. Some software, for example, Sage 50, have special audit reports built into the software at special request of HMRC, so that when they come to do a VAT inspection, they can see whether the business has been doing this. Businesses with slow-paying customers may have a different option, depending on their turnover level.
Cash VAT Scheme
This scheme is based on when a business pays and receives payment, rather than when the invoice is raised. This is a good scheme for businesses with slow-paying customers. The VAT return includes a list of payments and receipts, hence the business does not have to worry about paying HMRC before the business receives payment. This can ease the cash flow of the business. Any business with a turnover of less than £1.35 million can join the scheme and can stay until the turnover reaches £1.6 million.
Please be aware that if a business changes VAT schemes, there will be accounting adjustments that will need to be made, in order to ensure that the VAT is accounted for correctly. For example, if a business moves from the VAT Standard Scheme to the Cash VAT Scheme, outstanding customer and supplier balances will have already been accounted for in previous VAT returns and will need to be adjusted for in subsequent VAT returns. So if you intend moving schemes, please ensure that you get the necessary advice from your accountant first.
In my next blog, I will discuss the Flat Rate VAT Scheme for smaller businesses.