Freelancers, here’s a common VAT mistake. Are you making it too?

Sole traders should set aside 20% of their turnover -- as regularly as every week -- to avoid falling foul of the VAT office.

An accountant shares this top tip in a new video, in the hope that more self-employed people “settle their VAT liabilities every three months, smoothly and without hassle.”

But too often the accountant, Elena Meskhi, added that she gets told “there is no money” left when the VAT period ends and the VAT liability falls due to HMRC.

'Freelancers wrongly count the entire amount as belonging to them'

Invariably, there’s a “common” cause, as the boss of Elena Meskhi & Co explained in the video, targeted at tiny businesses specialising in digital.

“When the VAT-registered business receives money in their account, they count [it] as the entire amount belonging to them,” the accountant said. “And they budget on it.”

To overcome the risk of treating money received as money banked, she says freelancers can review their sales weekly, or fortnightly, “to set aside 20% of the dedicated amount.”

'Too many sole traders to count make this VAT mistake'

And if more self-employed people can start making the 20% set-aside, the volume of such individuals who get stuck in VAT season might hopefully reduce to an easier to grasp figure.

“I can't count the number of businesses I've come across in the last decade that did not budget for VAT,” Meskhi says.

“[Indeed] most VAT-registered business owners make this common mistake…[even though] budgeting for VAT is important.”

'No math needed'

Failing to budget for VAT is deterred against by HMRC with penalties – a reason not lost on most modern accountancy software, a former tax inspector told FreelanceUK.

Making Tax Digital, which traders are now part of, sees closer VAT monitoring and MTD-friendly accounting software shows the VAT liability to any point -- no math needed.”

The ex-tax official, Carolyn Walsh, last night continued: “Helpfully, this good estimation of VAT liability is visible on the first screen – the dashboard.

“And if the Xero, Sage or FreeAgent software says VAT liability £2,100.72 and Cash In Bank is £2,200.72, then happiness. But if ‘CIB’ is £2,000, then you’ve got HMRC trouble.”

'Put money aside to pay tax bills'

But at one of those accounting software platforms for freelancers, FreeAgent, its in-house tax expert said she approved of squirreling away 20% to cover the future VAT bill.

“I'd wholeheartedly agree with the idea of putting money aside regularly to pay business tax bills,” FreeAgent chief accountant Emily Coltman told FreelanceUK.

“That doesn't just have to be VAT -- it applies to all taxes, such as income tax for sole traders and corporation tax for limited companies”.

'Save for tax on a monthly basis'

Coltman conceded that, potentially not overjoyed at the idea at having to sit down every seven days to set aside 20%, some businesses “may prefer to save on a monthly basis.”

Now a payroll and compliance adviser via Oblako Ltd, Walsh believes the bigger issue is that VAT more precisely equates to a sixth of a total sales invoice, not 20%.

“The other thing with a 20% set aside is that VAT on purchases isn’t taken into account,” she added. “That’s VAT you get back. Freelancers mustn’t hamper cash flow unnecessarily.”

'Dedicated amount'

Nonetheless, “regular saving is an excellent way to make sure…money [is] to hand to pay” HMRC, maintains FreeAgent’s Coltman.

“Set aside 20% of the dedicated amount…[to] enable you to save that money,” Meskhi advises in her video. “And that ensures you have money to pay [HMRC] the VAT liability.”


9th May 2023

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