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TAX •  24 MAY 2024 • 5 MIN READ

10 common VAT mistakes small business owners should avoid

Man sitting at his home desk checking his VAT figures on his computer

Value Added Tax (VAT) can be tricky if you don’t deal with it on a daily basis. Fixing these mistakes can be expensive, so we’ve compiled a list of 10 common VAT mistakes you should avoid as small business owners.

1. Not registering for VAT at the right time, or deregistering when the business ceases

Whether to register for VAT can be tricky for new businesses as it’s hard to predict your business turnover in the next 12 months. 

As a small business owner, freelancer, or contractor, registering for VAT too early means you might lose the competitive edge on pricing, as you are charging an additional 20% on top of your sale price for goods and services. On the other hand, if you register for VAT too late, you may miss out on claiming VAT on any start-up costs (such as the VAT component on asset purchases). It’s also likely you face penalties and fines imposed by HMRC.

You must register for VAT if your taxable turnover exceeds £85,000 in any rolling 12-month period or will do so in the next 30 days.

If your business turnover stops making taxable supplies or joins a VAT group, you need to deregister for VAT. If your taxable sales fall below £83,000 you can also request to deregister for VAT from HMRC.  HMRC requires you to prepare a ‘final return’ - this should include the value of any stock or assets held at deregistration that you reclaimed (or could have reclaimed) VAT on when you purchased. 

2. Not putting money aside for VAT

For better cash flow, we recommend you put money aside for VAT. A good suggestion is to keep 20% of the proceeds from the sale of taxable goods and services in a separate bank account. If you're VAT registered, you’ll need to pay the VAT collected from your customers minus VAT paid to the suppliers in the same VAT quarter.  

3. Claiming VAT for the private use of business assets

You can’t claim VAT on private use of your business assets. If you need some help deciding which business assets you need to adjust, or how to calculate VAT for your business, you should seek advice from your accountant. They are familiar with the rules, and can help you make appropriate adjustments in the VAT filing period.

If you purchased your business assets using your personal account, you should let your accountant know. Otherwise, the claimable VAT amount will be missed.

Charlotte

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4. Miscoding transactions

Sometimes, VAT can’t be claimed against overseas suppliers. This is often overlooked by small business owners. 

You may or may not claim VAT on non-resident digital service providers. If the digital service provider is VAT registered in the UK, you can claim the VAT component on the expenses. If the digital service provider is not registered in the UK, you will need to operate the reverse charge and account for both input and output VAT.

Another common mistake on VAT returns is caused by confusion between exempt supplies and zero-rated supplies. For example, bank fees and Paypal fees are exempt supplies from VAT.

5. VAT on leasing and hire purchase

When you enter a hire purchase agreement for any assets or equipment, you can claim all the VAT upfront in the taxable period, as you are taking ownership of the assets or equipment.

If you only have the right to use assets or equipment for a limited time, you can claim VAT on each payment. Sometimes, however, VAT can be applied to a part of the regular payment. Leasing and hire purchase agreements must therefore be carefully considered for VAT purposes.

When purchasing a car that will have any element of private use VAT cannot be reclaimed. Similarily, when leasing a car, VAT reclaims are restricted to 50%.

6. VAT on buying and selling second-hand goods

If you buy second-hand goods from an individual who is not registered for VAT, you will not be charged VAT on the sale price. However, if the seller is VAT registered they will need to charge you VAT under the second-hand margin scheme (if they sell the items for more than they purchased it for). VAT will then be charged on the profit the seller makes from the sale. There is no requirement for a VAT invoice to be provided under the second-hand margin scheme.

Since a VAT invoice is required to reclaim VAT, you will not be able to reclaim the VAT you pay under the second-hand margin scheme. If you are buying from a VAT-registered trader you should instead ask for the second-hand margin scheme to not be applied.

The seller will then charge VAT on the full sale price, and provide you with a VAT invoice. Therefore, even though the amount of VAT you pay will be higher, you will be able to reclaim the VAT on the purchase price.

If considering buying a second-hand asset, we recommend you seek professional advice from an accountant or a tax agent.

7. Confusions about VAT on home office expenses

If you’re VAT registered, VAT on home expenses can be claimed in each VAT return period, or at the end of the financial year. It’s worth noting that rent and mortgage interest is VAT-free.

Calculating the VAT amount on home expenses can be confusing, so follow these 2 simple steps:

1. Calculate the VAT amount on your home office expenses

If your electricity bill is £105 in August, the VAT exclusive amount is £100 (£105/1.05), and the VAT amount on the electricity bill is £5 (home electricity is subject to the reduced VAT rate of 5%).

2. If you’re using the actual cost method, apply the percentage of your home office against your total home area on the VAT amount

If your home office takes up 10% of your total home area, you will need to apply this 10% to the VAT amount in Step 1. Therefore, the claimable VAT amount on the electricity bill is £5*10% = £0.5 for August. 

If you incur expenses specifically for running your business from home, for example, if you’re a self-employed pilates teacher and you buy pilates equipment for use in your home studio, you can claim the full VAT back on these purchases. Just be sure to get the VAT invoice in your business name. 

8. Confusions on VAT on motor expenses

If you have a vehicle that your business uses, the VAT on vehicle repairs and maintenance can be reclaimed as long as the cost is paid by the business, and the invoice is in the business’s name. 

9. Choosing the wrong filing and payment frequency and impacting cash flow

HMRC requires all businesses to keep accurate and complete records for at least 6 years. These records include invoices, receipts, bank statements and more. 

Under Making Tax Digital, you must keep the majority of your VAT details digitally. You can find more information here

To make your record-keeping process more efficient, you can utilise softwares (e.g. HubDoc). These apps allow you to take photos of your receipts using your smartphone, and then upload them to your cloud-based software (e.g. Xero).

10. Not considering the VAT flat rate scheme

The VAT flat rate scheme offers a simplified way of dealing with VAT. It essentially means that rather than calculating your input VAT and output VAT, and submitting a VAT return on this basis, you instead pay a flat rate % of VAT over to HMRC.

The % you pay to HMRC depends on the industry you operate in. You still charge 20%, 5% or 0% of VAT on your taxable supplies, depending on what type of supplies you make.

The flat rate scheme is only available to businesses with taxable turnover of less than £150,000 a year. For full details of the flat rate scheme, you can learn more here, or speak to your accountant.

Who are Beany? 

We’re an online accounting firm that is always right here for you, your accounting pain relief. The most advanced technology lets us work way more closely with you than a normal accountant world. ​We have a dedicated team of certified accountants and a support team to take care of your business no matter where you are, so you can focus on growing your business. We take out the ‘fluff’, break down the barriers and get things done. Looking out for you is what we are all about. Register today.

Charlotte Wass

Charlotte Wass

General Manager, Beany UK

Chartered Accountant and Chartered Tax Adviser based in London. I love autumn, otters and Malteasers, and I hate spiders, peanut butter and the London Underground.

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