VAT Schemes – not your normal standard of cash VAT returns
The ICB Level 3 syllabus covers the production of a VAT return under standard or cash based VAT, with returns made quarterly. As you progressed through your studies you would have learned how to post transactions that included VAT at one or more of a number of VAT rates (standard, reduced, zero and exempt) plus how to deal with out of scope items. You would have covered how to deal with invoices from non-VAT registered suppliers as well as those customers and suppliers based either in another EU country or one who is based outside of the EU entirely.
This is the first of two articles that covers different types of VAT schemes that are available. Part 1 covers returns that are submitted monthly or annually and also looks at the flat rate scheme. Part 2 will look at retail schemes including the second-hand VAT margin scheme and the Tour Operators Margin Scheme. We may even take the plunge with a Part 3 and look at partial exemption and how to deal with the purchase of large capital items!!
If you have still missed out on the whole concept of Making Tax Digital, this also acts as a reminder to all that from 1 April 2019, if the taxable turnover of the business is over the VAT threshold, then businesses must register to submit their returns via MTD compatible software, unless the business falls into one of the deferred areas in which case the start date is 1 October 2019, or they are in receipt of an exemption to file online.
If taxable turnover is below the VAT threshold but the business is VAT registered, then they can still use the existing reporting system. Such business may register for MTD voluntarily but once they do, they cannot return to submitting returns via the ‘old’ government gateway system.
VAT returns normally cover a quarterly period (i.e. April, May and June or the equivalent quarter if it starts with a different month), with the return and payment due submitted and cleared electronically by 1 month and 7 days later.
HMRC offer businesses the chance to use one of a number of other schemes which are designed to help different types of businesses. Over the next few months, we will cover the main schemes, linking them to MTD as appropriate.
This month we will cover payments on account, monthly VAT returns, annual VAT returns and the flat rate scheme.
Payments on account arrangements
‘Payments on account’ are advance payments made towards the VAT bill. If VAT returns are sent quarterly, and the business owes more than £2.3 million in any period of 12 months or less, HMRC will tell the business that they must make payments on account. The £2.3 million threshold includes VAT on imports and moving goods into and out of excise warehouses.
The due dates for payments on account are the last working day of the second and third months of every VAT quarter no matter what the period end date is. Once the return has been completed, the amount of balancing VAT due must be paid within one month of the last day of the VAT period (which is actually the ‘end’ of month 1 in the next VAT period). The 7-day extension for paying electronically does not apply to payments on account.
If the VAT liability falls below £2.3 million in the reference period, then HMRC will remove the business from the need to make payments on the account after a period of 6 months.
Note: those businesses who are required by HMRC to make payments on account have been given a deferral to 1 October 2019 before they must make their returns under MTD.
Monthly VAT returns
Making payments on account, with quarterly returns, does not suit all types of businesses that fall within these requirements. Businesses can choose to make VAT returns and payments monthly. The business must apply, either online or by completing and sending in the relevant form and may have to continue making monthly returns for at least one year.
When submitting monthly returns, the extra 7 days allowance for payment can be taken provided that the payment is made using an electronic payment method.
For monthly VAT returns the first return under MTD is the return due for the month of April 2019, which is (was!) due by 7 June 2019.
It is really only the largest of businesses who should consider making monthly VAT returns as the work-load increases considerably and the time frames are much shorter. The alternative to this is where businesses often have a VAT repayment due on a regular basis and completing monthly returns will ensure this happens more quickly. Such businesses could be those who purchase goods within the UK (and hence pay input VAT) but sell abroad charging zero VAT, thus making cash flow quite problematical without a regular VAT repayment.
VAT Annual Accounting Scheme
Small businesses with a turnover of less than a stipulated amount can elect to make returns annually instead of quarterly. The stipulated amount is notified yearly in the budget. Businesses can currently join the scheme if their estimated taxable turnover is £1.3 million or less.
This does not mean that the VAT itself may be paid annually. Normally the business calculates the amount of VAT due each month or quarter and sends this to HMRC (similar to the payment on account detailed above but this is a voluntary arrangement). Alternatively, a business can estimate the total VAT due for the year and send this in twelve equal instalments.
The actual return is completed at the end of the year and a final balancing figure sent (or reclaimed if VAT has been overpaid). The advantage of this is that it can even out VAT payments and smooth cash flow.
The benefits of this scheme are:
- no big VAT bills at the wrong time because payments are spread throughout the year
- easier budgeting and cash flow planning because instalments are known from the start
- less time spent on VAT because only one return has to be filled in each year instead of the usual four
- Two months are allowed to complete and send in your annual VAT Return and balancing payment, instead of one
- The VAT Return year can be chosen to suit the business.
This scheme may not be suitable if the business usually gets repayments of VAT, as it will have to wait a whole year for the repayment. However, in this case, it might be possible to register for monthly returns (as above) so that the repayment will happen quicker.
Note: the Annual VAT scheme is one that must be registered for MTD from 1 April 2019 although the first submission date for the annual return does not change. Businesses will therefore have to keep their digital VAT records from 1 April 2019 and use software to complete the VAT return which is due on 7 May 2020.
Sublime Symmetry is a sole trader business. The owner, Petra, estimates that its annual VAT bill will be £24,000. She elects to pay this off in twelve monthly instalments of £2,000 per month. At the end of her financial year, she calculates that her sales, purchases and expenses (exclusive of VAT) are as follows:
Sales £225,000 Standard-rated
Purchases £36,100 Standard-rated
Rent £45,000 Standard-rated
Water Rates £25,000 Exempt
Gas & Electricity £2,500 Standard-rated
General admin £1,750 Standard rated (note, however - this figure includes postage amounting to £350 which is exempt)
Motor expenses £2,500 Standard-rated
Wages £25,000 Outside the scope
Value of outputs £225,000
VAT due on outputs £225,000 x 20% = £45,000.00
Value of standard rated inputs Purchases £36,100
Gas & Elec £ 2,500
Admin £ 1,400
Motor £ 2,500
Total standard rated items £87,500
Exempt items Rates £25,000
Postage £ 350
Total inputs £112,850
VAT on taxable inputs £87,500 x 20% = £17,500.00
VAT due for the year = £45,000.00 - £17,500.00 = £27,500.00
VAT paid in first 11 months of year = 11 x £2,000 = £22,000.00
VAT due with return = £27,500.00 - £22,000.00 = £5,500.00
If the VAT paid across the year amounted to more than £27,500 then Petra can apply for a VAT rebate.
For all of the above schemes, the bookkeeping entries will be exactly the same as for a normal standard or cash based VAT return. It is simply the submission of the returns and the timing of the payments that is different.
The Flat Rate Scheme
The flat rate scheme is the first scheme we will look at which involves amendments to the way that the transactions are recorded.
The scheme is designed to help small businesses by allowing them to calculate their VAT payment as a flat rate percentage of turnover including VAT. The percentages are decided according to the trade sector in which the business lies. Under the scheme, the business will not be able to reclaim any of the VAT it pays on its inputs, as this is taken into consideration as part of the percentage calculation. The only exception to this is for the purchase of certain capital assets over £2,000.
The main benefit of this scheme is that it can reduce the time spent accounting for VAT because the business does not have to record the VAT charged on each individual purchase and sale, although the ‘normal’ rate of VAT must be charged on invoices sent to customers (covered in more detail below).
The VAT flat rate depends on the type of businesses. Some examples of the percentage rates applied are:
Accountancy or bookkeeping
Hairdressing or other beauty treatments
Retailing food, confectionery, tobacco, newspapers or children’s clothing
Businesses in their first year of VAT registration can also benefit from a 1 per cent reduction in the flat rate. For example, if a business belongs to a sector which has a flat rate of 10%, it can apply a flat rate of 9% in its first year.
To join the scheme, VAT turnover must be £150,000 or less (excluding VAT). Businesses will be excluded from joining if they have committed a VAT offence within the last 12 months or have been able to join a VAT group in the last 24 months.
To use this scheme an application must be made to HMRC, who will determine the applicable business sector and inform the business of the relevant rate to use. The flat rate scheme can be used in conjunction with certain other schemes (such as the annual accounting scheme outlined above) but you should check with HMRC to see what combinations can be used in any particular year.
Businesses can choose to leave the scheme at any time and must leave if they are no longer eligible to remain in it. They cannot re-join the scheme within a period of 12 months.
A business which hires out goods is registered under the flat rate scheme and is given the VAT percentage of 9.5%
They have sales of £24,000 exclusive of VAT in the quarter and inputs of £8,000 plus VAT for the same period. Most of their sales are to non-VAT registered individuals, few of whom ask for a VAT receipt.
Under the standard VAT scheme their VAT return would show the following amounts:
VAT on outputs 4,800
VAT on inputs 1,600
VAT due in the quarter 3,200
Under the flat rate scheme, the amount of VAT due would be 9.5% of £28,800 = £2,736
This is lower than the amount due under the standard rate scheme and would also save on bookkeeping transactions as all items are registered gross of VAT in the accounts and a manual journal entered to record the VAT due.
A management consultancy is registered under the flat rate scheme and is given the VAT percentage of 14%
The business issues sales receipts for £30,000 plus VAT in a quarter.
They have inputs of £6,000 plus VAT in the same quarter.
Under the standard VAT scheme their VAT return would show the following amounts:
VAT on outputs 6,000
VAT on inputs 1,200
VAT due in the quarter 4,800
However, under the flat rate scheme, the VAT due is calculated at 14% of the VAT inclusive sales.
This means that if in any one quarter, the VAT inclusive value of sales is £36,000 then the VAT due for that quarter will be:
36,000 x 14% = £5,040
This is higher than the amount of VAT due under the standard scheme, so in this case, the business would have to decide if it was worth using the flat rate scheme.
Limited cost business
The flat rate scheme was set up, not to save money for the business (as in example 1 above), but to simplify the way such businesses calculated their VAT returns. Look at the following example:
A legal services business has outputs excluding VAT of £95,000 in a quarter. However, its VAT-able inputs are only very low in comparison at £1,100.
Under the standard VAT scheme their VAT return would show the following amounts:
VAT on outputs 19,000
VAT on inputs 220
VAT due in the quarter 18,780
Under the flat rate scheme, this type of business would pay 14.5% of the gross taxable turnover i.e. £114,000 = £16,530
The higher the taxable turnover where there are low VAT-able inputs, the larger the difference between the two schemes. This means that businesses with very low inputs in relation to their outputs are reducing the amount of VAT paid by a considerable amount.
To enable the VAT to be properly recovered, over the past few years, HMRC have introduced the concept of the ‘limited cost business’. In this case, if the business has inputs which are less than either 2% of turnover, or less than £1,000 (if costs are higher than 2%) then a fixed rate of 16.5% is applied.
In the example above, the percentage of costs to taxable turnover is 1.16% so this business will count as a low-cost business and the flat rate scheme percentage applied would be 16.5% making the VAT due £18,810 – still lower than if using the standard scheme but much closer in total.
Invoices and recording transactions in the accounts
In an accounting system, when using the flat rate scheme, all entries can be made inclusive of VAT which makes the data entry far simpler. However, this will show the balance on the sales account as gross of VAT. A journal entry must then be made to remove the VAT element and transfer it to the VAT Liability Account in current liabilities, ready for the return to be made.
When issuing invoices to customers, a business registered under this scheme must still show VAT as normal on its sales invoices. However, if you use your accounting system to produce sales invoices, then this will have to show the VAT in the ‘normal’ way. This means that the value of sales in the accounts will be net of VAT and a further journal entry must be made to correct the accounts and to amend the value of VAT owed in the VAT liability Account as before.
Note: At self-assessment time, for the self-employed section of the return, there is a question on the form that asks if the figures are inclusive or exclusive of VAT – if using this scheme, answer “inclusive of VAT” and enter the gross figures.
If you buy a fixed asset for more than £2000 you will be able to claim the VAT back on the purchase in the normal way, i.e., showing VAT at 20% and not at the percentage given for the particular trade sector.
If such a transaction is made the VAT must be recorded in the normal way, showing the entries in the VAT account.
Further details can be found in the HMRC notice 733
Submitting Flat Rate Scheme VAT returns under MTD
Using the flat rate scheme will involve some form of journal entry in order to ensure that the VAT return figures are correct. Users of the Flat Rate Scheme fall into the group for which returns apply from 1 April 2019 so it is vital that you check how your software will deal with this. You must maintain the digital links for the transactions. The best route if you are unsure of what to do is to contact your software provider to ensure you can complete this process correctly.
The Agricultural Flat Rate scheme
The Agricultural Flat Rate scheme allows certain agricultural businesses to register for this as an alternative to registering for VAT. They cannot join the scheme if the value of their non-farming activities is above the VAT registration threshold; neither can they join if their main business is the buying and selling of animals.
Farmers (and some horticultural businesses) who register for this scheme do not account for VAT or submit returns and so cannot reclaim input tax, but they can charge and keep a flat rate addition (FRA) when they sell goods or goods and services to VAT registered customers.
The flat rate addition is not VAT but acts as compensation for losing input tax on purchases. It is not intended as reimbursement for all the VAT incurred on purchases. The flat rate addition is 4%.
Those readers who work within agricultural businesses should already be familiar with this scheme but for further information see VAT Notice 700/46.
Part 1 of this series looked at the different ways that VAT under standard or cash based schemes are recorded, reported and paid (or reclaimed) from HMRC, quarterly, annually or monthly. It also looked at the flat rate scheme, designed to assist smaller businesses in simplifying their accounts and returns.
Next month, Part 2 will cover the various retail schemes that are in place at present to assist in the recording of sales in retail establishments that are numerous but very small and for which the recording of individual VAT amounts is very time-consuming. It will also look at the second hand VAT Margin Scheme and the scheme that applies to tour operators.