VAT for startups

We’ve all heard of Value-Added Tax, or VAT. And we know we pay it on the goods and services we buy. But how does VAT affect the running and taxation of your business?

Bilal Mahmood gives the lowdown on everything your startup needs to know about registering for, accounting for and paying VAT.  

What impact does VAT have?

Whether it’s a service you provide, a product you make or a biscuit you bake, your job is to collect the VAT on that product/service and pay it to HM Revenue & Customs (HMRC). 

Unless of course it’s a Jaffa Cake, which, infamously, is classed as a VAT-free cake, not a luxury biscuit. Having to charge VAT once you reach the registration threshold can have a significant impact on your competitiveness, especially if you’re a retail, manufacturing or production business.

As a startup, it’s worth considering when you will need to add VAT in the future as it will either eat into your margin, or force up your wholesale/retail price. Consider the example below:

You start up a widget business, and can buy widgets for £9 and sell them for £12. Your £3 margin gives you a competitive edge when starting out compared to the competition, however as soon as you reach registration you either: Leave your selling prices at £12. £2 has to be paid to HMRC for the VAT so your net selling price is only £10 and your margin is only £1. OR You increase your selling price to £14.40 (£12 +VAT). Your margin remains at £3 but the selling price of £14.40 means you will lose the competitive edge.

So, it’s worth thinking very carefully about when, and if, the time is right to register for VAT.  

When does my start-up need to start paying VAT?

The magic number is £83K. When the turnover of your business gets to £83,000, you must register for VAT with HMRC and start collecting and paying the tax on your eligible products or services.

With that magic number ingrained in your mind, here are some practical tips for making sure your startup is ready for VAT:  

• Keep on eye your turnover figure – have a regular overview of your turnover (easy to do if you’re using a cloud accounting package like Xero) and check how close sales are bringing you to £83K. Once you’re close, start planning ahead for paying VAT.
• Do some financial housekeeping – it helps enormously if your financial processes are working efficiently and giving you the numbers you need. Clean up any messy accounting and give your finances a spring clean so you’re ready to roll.
• Register early! – as soon as you start approaching £75-£80K turnover, register for VAT. The registration process only takes two weeks or so, but the sooner you start, the more ready you’ll be for the additional admin that VAT requires.
• Plan your quarterly VAT payments – your business is responsible for paying VAT to HMRC every quarter. So it’s sensible to have a separate deposit account for VAT and to work those payments into your budgeting and cashflow for each quarter.

You can register for VAT even if you’re not up to the £83K mark. Some startups will register for VAT early to add a little kudos to the brand and give the impression they’re a bigger concern.

Registering right from the start does show prospective customers and investors that you’re serious about growth. But bear in mind the potential impact of paying VAT and the effect it can have on cashflow and margins.  

How tricky is VAT to set up?

Registering for VAT isn’t hugely complex – if you’ve got some finance experience, you could do it yourself.

But there’s real value in getting your accountant involved right from the beginning. Anything to do with HMRC can make people nervous, and working with a VAT specialist helps to remove any worries – and frees up your time to focus on growing your fledgling startup.

There are different ways to account for VAT, and an accountant can help you decide on a method that makes the most sense for your business.

Accrual accounting

The accrual method involves paying your VAT based on the invoice or purchase date. So, if you invoice your customer in one VAT period but don’t get paid until the next quarter, that VAT is payable in the earlier period.

The cashflow problem If your invoices don’t get paid on time, that racks up debt and you can end up with cashflow issues at the point when VAT is due.

Cash accounting

To simplify the VAT process for small businesses, you can apply to HMRC to use cash accounting (if your turnover is under £1.35M). With this method, you account for VAT only once payment has been received, not from the date the invoice was sent – removing the potential cashflow issue.

Flat-rate scheme

To make VAT even easier, you can also apply for the flat-rate scheme. You continue to charge VAT at the relevant rates, but when it comes to paying HMRC, you pay a simple flat rate on everything. You simplify your bookkeeping, pay less in VAT and keep money in the business to invest in growth.  

VAT needn’t be taxing

So, there you have it. VAT’s not as scary as you thought, is it? With the right awareness, forward planning and professional advice you can make VAT work for your business – and even improve your cashflow and annual profits. Our top 3 actions points are:

• Move to cloud accounting to keep a close eye on when that £83k turnover is close and be ready for Making Tax Digital.
• Plan your tax costs and squirrel your VAT away so it’s ready to pay each quarter.
• Talk to an accountant and use the accounting method that best suits your startup.