In the United Kingdom, when you register for VAT, you can often choose how you will report your VAT to the tax authority. The method of reporting VAT is known as a VAT scheme. Making the optimal choice could have important consequences for your small business down the road.
In addition, at some point, a small business may have to change VAT schemes. A company may choose to change VAT schemes because an alternative scheme may prove more beneficial. Alternatively, the business may no longer be eligible for its current VAT scheme and may be required to change.
In most cases, VAT-registered entities will follow the standard VAT reporting process: the VAT Standard Accounting Scheme. Under this scheme, the taxable person (i.e. entity registered for VAT) keeps a record of all sales and purchases. The standard VAT scheme is a form of accrual accounting. VAT charged and VAT paid is calculated according to the date of the invoice, rather than when the cash is actually received.
Under Standard Accounting, VAT received (output VAT) is compared with the VAT incurred on purchases (input VAT). The calculation of output VAT to input VAT determines how much VAT the business owes tax authorities. In cases where the company expended more VAT on business expenses than it received, it may apply for a domestic VAT refund.
There are also a number of alternative VAT schemes available that could be more suitable for a particular business.
In contrast to Accrual Accounting principles, which are based on the date listed on the relevant invoices, Cash Accounting accounts for transactions based on the date payments actually occur.
The Cash Accounting VAT Scheme is generally used by smaller businesses that may not receive prompt payments.
In most cases, the amount of VAT an entity pays is calculated according to the difference between VAT charged, and VAT received. That is the case regardless of whether you apply accrual accounting or cash accounting principles.
The Flat Rate VAT Scheme works differently. With the VAT Flat Rate Scheme, the company pays a fixed rate of VAT, set at a percentage of turnover. Under UK VAT rules, this scheme is only available to entities with a VAT inclusive turnover below £150 000.
Under HMRC rules, a business can only change its VAT scheme at the start of a new accounting period.
However, changing your VAT scheme is about more than notifying tax authorities. You need to change the way your accounting systems process VAT. This can involve significant administrative effort.
For example, changing from accrual accounting (under the standard VAT scheme) to cash accounting requires including all unaccounted sales and purchases, even if they have not yet been paid.
As any errors on your VAT returns could lead to penalties, businesses should ensure they have the VAT software and guidance they need to prevent errors when changing invoice schemes.
A business may be required to change VAT schemes because its turnover exceeds the permissible amount for the flat rate scheme. There may also be compelling business reasons to change VAT schemes. A different accounting method may be more suitable for a business as its operations change.
Changing VAT schemes can have significant cash flow consequences. It may also affect how much VAT a company can reclaim. Changing a company’s VAT scheme is therefore, often a complex decision, and businesses will usually benefit from consulting a specialist VAT advisory service.
With the right advice and technology, changing your VAT scheme can be a manageable process. However, it is better to avoid the cost and hassle in the first place. Businesses can ensure long-term efficiency and cost-saving by choosing the most appropriate VAT scheme in the first place.
As the world’s VAT recovery and compliance specialists, VAT IT will provide the guidance, support, and technology your business needs to optimize VAT compliance and maximize VAT recovery. As the business grows, or VAT regulations change, VAT IT will ensure you adapt as efficiently and cost-effectively as possible.