Do I really need to register for VAT?
HMRC Guidance states that you must register for VAT within one month of your turnover (or total sales) exceeding £85,000 or if you expect your turnover to exceed £85,000 within the next thirty days.
The language is straightforward, but in practice you must monitor your annual turnover at monthly intervals. It would not be acceptable for you to wait until the end of your tax year is complete and then ‘discover’ that your turnover was £130,000. For example, at the end of March 2022, you need to monitor April 2021 to March 2022; then at the end of April 2022, you need to monitor May 2021 to April 2022, then June 2021 to May 2022, etc. i.e. any 12 month period where you are over the VAT threshold, you need to register.
We advise all our clients who are anywhere near the threshold to be looking at it well in advance of reaching £85,000. This gives you some options that you won’t have if you leave it until you cross the threshold.
Do I want to be VAT registered?
Of course every business wants to grow in size, but how fast and at what cost? Consider the examples below:-
Peter is a self-employed painter/decorator. His turnover is £84k and his profits are £42k. He has no loans to repay and his insurance costs are minimal. But, the vast majority of Peter’s customers are domestic consumers who are not VAT registered and cannot claim back the VAT that Peter will have to charge them.
When he registers for VAT, Peter has to pay £14k VAT on his sales, but the most VAT he can claim back on his purchases is £7k; so to recover his new £7k loss he has to raise his prices by 8.5% or do 17% more work, to make the same amount of profits as before.
Bear in mind also that some of Peter’s expenses are for purchases that may not include VAT like insurance, and vehicle finance. So his loss might be more than £7k.
In this case Peter should seriously consider if an extra £1k or £2k of sales is worth doing. He has to get to a turnover of more than £98k fairly quickly to be better off.
Paul is self-employed and fits and maintains air conditioning systems. For comparison let’s say his turnover is £84k and his profits are £42k. However, the vast majority of Paul’s customers are commercial businesses who are VAT registered and are able to claim back the VAT that Paul will charge them.
After registering for VAT, Paul now has to pay £14k on his sales and can claim up to £7k on his purchases. But because his customers can claim back any VAT he charges them, Paul simply adds VAT onto his sales, bringing in an extra £14k to cover the VAT due on his sales, but he still gets to claim the £7k on his purchases, so Paul effectively increases his profits by £7k. Alternatively, he could reduce his prices to make his business more competitive and hopefully grow it faster.
The above examples highlight the difference between the businesses: If your customers are individuals (not VAT registered), then registering for VAT will reduce your profits and/or make you less competitive. If your customers are businesses (VAT registered), registering for VAT will increase your profits and/or make you more competitive.
If your business is more Paul than Peter, then you should register for VAT; it will be to your advantage. But if you’re more Peter than Paul you might want to avoid registering.
How can I avoid VAT Registration?
Until you cross the VAT threshold and are forced to register, there are many options:-
a) Limit your work to keep your turnover down
This might sound strange, but in Example 1 previously, it is evident that earning an extra £1,000 would result in a loss of £7,000 per year. So if you’re happy with your profits just stick where you are. You may still be able to grow your profits without growing your turnover, by focussing on the more lucrative, higher profit work.
b) Create a diversified new business
If you’re self-employed as a sole trader there is absolutely nothing to stop you from having two separate self-employments in your annual tax return. The problem is that for Sole Traders, VAT Registration is for individuals and the combined turnover of the two businesses will count as crossing the VAT threshold.
However you can still split your trading into two businesses by making one of them a Limited Company or a Partnership. But the two businesses have to be different in the trade that they operate in, or the services that they sell.
For example, going back to Peter in Example 1; if Peter was doing an additional trade like plastering, as a prerequisite to his decorating, it would be OK for Peter to divert that portion of his work that is plastering to a separate plastering business. As long as the customer gets separate invoices for plastering and decorating, it is legal. So the turnover for the plastering business is £20k and his turnover for decorating is £80k, but he does not have to register for VAT because the plastering business is a separate limited company or partnership.
Note that HMRC refer to this as ‘disaggregation’ and you must be careful to keep separate bank accounts and different accounts records and avoid transactions between the two businesses.
Please contact me if you need more detailed options.