The Basics of VAT for freelancers
What is Value Added Tax (VAT)?
VAT is a tax charged on sales made. If a business is VAT registered, they have to charge VAT on sales. However, the business can then reclaim VAT on purchases made from other VAT registered businesses.
What is a VAT return?
At the end of every three months, you have to make a return to the VAT office (a VAT Return) which details how much VAT you have charged and how much you are reclaiming. You will then pay the difference, or if you have claimed more than you charged, the VAT office will send you the difference.
In most cases, VAT is charged at 20% although there are situations where a sale can be either 'zero-rated' in which case you do not charge VAT but you can reclaim it, or 'exempt' in which case you can neither charge nor reclaim VAT.
What is the VAT threshold?
A company must register for VAT once the turnover exceeds the threshold of £85,000 (for the tax year 2023/24) within a year, or else you can even choose to register your business for VAT before hitting the threshold.
There might be some cases where you would want to volunteer to register your business and here is a reason: if you are dealing mostly with other VAT registered businesses then you would register to enable you to reclaim VAT on any business purchases you make, for example, computer equipment and training courses. If your business primarily deals with consumers or businesses that are not VAT registered it may or may not be beneficial still to make a voluntary registration. Therefore, you should look at the amount of VAT that you can claim back as well as how price-sensitive your market is. Your freelancer accountant can guide you through this and advise you on the direction you should take.
How and when to register for VAT?
You can choose to register for VAT even if your turnover is below the threshold of £85,000, so if you want to do that for your freelance business then can register on the gov.co.uk website. This is how most businesses will register for their VAT as it is quick and easy. Some businesses also opt to appoint an accountant to register the business on their behalf.
There is another potential benefit of being VAT registered and that is what is known as the 'VAT Flat Rate Scheme'. This is a simplified method of calculating VAT. You are given a fixed percentage of your particular type of business and then you apply this percentage to your gross sales. You cannot reclaim any VAT on this scheme, but broadly speaking if you do not claim much VAT back any way you will be better off using the Flat Rate scheme. A flat VAT scheme can also help with the cash flow of your business. The flat rate scheme requires the business to have an annual turnover of up to £150, 000 to qualify.
Here is an example of how the flat rate scheme works. Assume your VAT flat rate to use is 9.5%.
So, when raising a sales invoice, you still charge VAT, so a sale of £100 would look like:
- Net Sale £100
- VAT £20
- Gross sale £120
When declaring the VAT payment to make to the VAT office you would use the flat rate percentage, so 9.5% on the gross sale (£120) making £11.40 payable, instead of the £20, so you get to keep the difference. Be aware though that unlike the ordinary VAT you cannot claim any VAT on most purchases, so before signing up with the Flat Rate, make sure your accountant checks to see whether you would actually be better off.
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