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VAT – A CLOSER LOOK

Reading Time: 5 minutes

What is VAT? At its core, VAT is a sales tax paid by the consumer not a business tax. Think of VAT as a type of sales tax that represents the ‘value added’ to a product between a supplier and the buyer.

VAT has been contentious since its inception in 1973, and probably even more so since 1980 when Nigel Lawson applied it to hot food takeaways. Anti-tax lobbyists accuse VAT of being a double tax because consumers pay for goods and services from already-taxed income.

VAT PERCENTAGE OVER THE YEARS

The standard rate of VAT has changed over time, with Governments choosing to raise or lower this tax depending on their priorities and the state of the economy. The rates were:

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We need to change the way we view VAT. The fact is this, you are collectors, and you collect this money on behalf of the government, and you are doing this for free. Well, actually, you could argue you do it at a loss as there are costs involved in collecting, holding and passing these funds on. 

VAT on hot food is set at 20%, we can get into it being too high, but this is the reality we live in. I think there is a part of this government that would consider the merits of lowering it, However, for the moment there is far too much happening for them to listen or to act. 

To fully understand the rates of VAT and how they differ across Europe, We have put together a table with all the main figures broken down.

Notably, in many countries in Europe, the rate is the same for all food whereas the U.K has zero rates for much of our food but the standard rate of VAT for hot food takeaway.

EUROPEAN VAT RATES

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VAT Flat Rate Scheme explained

The VAT Flat Rate Scheme for small businesses, including small limited companies, has existed since the 2002 Budget.

The VAT Flat Rate Scheme is not a different rate of VAT, but a simplified way for businesses to account for they VAT they collect and hand over to HMRC.

Until 2017, the VAT Flat Rate Scheme was also a good way for small businesses to boost their profits. Since the flat rate of VAT that they paid to HMRC on their sales was often considerably lower than the headline VAT rate they charged their clients, allowing them to pocket some of the difference.

This advantage was significantly reduced with effect from 1 April 2017 when the UK government decided to crack down on what it considered to be aggressive exploitation of the VAT Flat Rate Scheme.

Is my business eligible for the VAT Flat Rate Scheme?

To be eligible to join the VAT Flat Rate Scheme, your business must be VAT-registered and expect your VAT taxable turnover to be £150,000 or less (excluding VAT) in the next 12 months.

You have to leave the flat rate tax scheme if on the anniversary of joining, your turnover in the past 12 months was more than £230,000 (including VAT) or if you expect it to be in the coming 12 months.

Alternatively, your business may wish to cancel its VAT registration if your turnover (excluding VAT) falls below £85,000.

The introduction of the 12.5% higher flat rate in 2017 may have reduced some of the attractiveness of the VAT Flat Rate Scheme to small businesses.

However, it is still important that you carefully consider whether it would be better for you to sign up for the scheme rather than the Standard VAT Accounting Scheme if you either want, or need, to become VAT-registered.

Standard VAT Accounting Scheme vs VAT Flat Rate Scheme

With the Standard VAT Accounting Scheme, your business must pass on the 20% tax that is charged on eligible sales in the previous quarter to HMRC.

Yet you can also reclaim the VAT that you make on your purchases.

As a result, the amount of VAT that your business pays or claims back from HMRC is usually the difference between the VAT charged by your business to its customers and the VAT that your business pays on its own purchases.

With the VAT Flat Rate Scheme, your business passes on a fixed rate of VAT to HMRC and can keep the difference between what you charge your customers and what you pay to HMRC.

You can’t reclaim VAT on your purchases, however, except for certain capital assets costing more than £2,000.

Making Tax Digital

The UK government is trying to digitalise tax filing for VAT, Income Tax and Corporation Tax etc.

With the recent introduction of the Making Tax Digital (MTD) program, they are aiming to make submitting tax returns easier by helping companies automate payments and returns.

This program will simplify tax filing, put an end to tax-evading activities, and decrease the costs incurred by HMRC.

Companies with a turnover of more than £85,000 are required to digitally store their records, and use software to submit their VAT returns.

GOV.UK has a step-by-step guide to help small businesses follow the rules for Making Tax Digital for VAT.

We know VAT can drive people crazy but how about these anomalies.

If a gingerbread man has two chocolate spots for eyes, then there’s no VAT on it, any other chocolate decorations and VAT applies.

The sale of a horse is standard rated. However, the sale of a dead one (for horse meat) is zero-rated.

Orange squash, petrol, ice cream, and poodle food are rated as “luxuries”, while caviar, lap dances, and labrador food are not.

The hire of bumblebees for pollination are taxed under VAT, while honey bees are not.

Chocolate covered shortbread is subject to VAT, but if you add a layer of caramel and make it Millionaire’s shortbread, it’s not.

Orange juice is zero-rated. Lemon juice is zero-rated. Mix them, and you have a standard rated product.

Buying a coffin is standard-rated but hiring a hearse is VAT free.

Most nuts that are sold still in the shell are zero-rated, while those out of their shells attract the tax.

Jaffa cakes are cakes, Pringles are crisps, and now Lucozade Sport is a beverage. That’s what the Upper Tribunal has ruled, so the drink is now subject to VAT. So now we know.

VAT’s importance to the UK Economy

The charts below show tax receipts in both cash terms and as a share of national income (GDP). Receipts measured in cash terms are a simple metric for analysing trends over time. But without putting the cash amount into context – by asking how much national income is available to be taxed – interpreting changes in cash receipts is difficult, particularly over long time periods.

Revenue has soared 80% (£125bn) since the rate increased from 15%but could it come down after Brexit or Covid-19?

VAT now contributes 21% of the UK tax take – up 3% from 2008.

HMRC’s total tax take increased to £594bn in the 2017/18 financial year.

(source This Is Money.co.uk)

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The taxman's top income sources.

Tax name % of HMRC tax take 2008/09% of HMRC tax take 2010/11% of HMRC tax take 2017/18
VAT17.6% (VAT rate 15%)18.4% (VAT rate 17.5%)21% (VAT rate 20%)
Income Tax34.4%33.8%31%
NICs21.7%21.3%22%
Corporation Tax9.9%9.5%9%
Fuel Duties5.5%6%5%
Stamp Duty Land Tax1.1%1.3%2%
Capital Gains Tax1.8%0.8%1%
Other8%8.9%9%

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Here are a few tips for managing VAT.

Open a new bank account, call it the VAT fund. Every week divide your turnover by six and add 1/6th of that into that account. This will help you manage the process of collecting, handling and paying it quarterly. It means you don’t have to rush around in a panic at the end of month three and you will always have a little money left in the account at the end of the quarter. For example, if you take £3,000 in week one, you should deposit £500 into your VAT fund account. 

Don’t include VAT in your turnover, it is not your money, so it is best to learn how to function without that money on the balance sheet. For example, if you took £1,000 on a Friday, then £833.33 is your sales, and £166.67 is what you are passing on to the HMRC. 

Display on all your printed menus and menu boards that “prices include VAT at the applicable rate”.

Make sure you show the VAT contribution on your printed receipts.

Here is a handy calculator to help you calculate VAT.