Value Added Tax is one of the most significant taxes a small business deals with. Get it right and it is manageable. Get it wrong and HMRC’s penalty regime bites quickly. Whether you are approaching the VAT registration threshold or already registered, these tips will help you make better decisions and keep more cash in the business.
Know When to Register – and When Not To
You must register for VAT when your taxable turnover exceeds £90,000 in any rolling 12-month period. But voluntary registration below the threshold can be a smart move in the right circumstances.
| Scenario | Register Voluntarily? |
|---|---|
| Most customers are VAT-registered businesses | Yes – they reclaim your VAT, so it costs them nothing |
| You sell mainly to consumers | Probably not – your prices effectively rise by 20% |
| You have significant input VAT to reclaim | Yes – you recover VAT on purchases even before hitting the threshold |
| You want to appear larger or more established | Yes – some businesses prefer VAT-registered suppliers |
Monitor your rolling 12-month turnover regularly. If you breach the threshold without registering, HMRC backdates the registration and you owe VAT on sales you may not have charged VAT on.
Choose the Right VAT Scheme
HMRC offers several schemes designed for smaller businesses. The right choice depends on your turnover, cost structure and cash flow pattern.
The Flat Rate Scheme
The Flat Rate Scheme simplifies VAT by letting you pay a fixed percentage of your gross (VAT-inclusive) turnover to HMRC, rather than calculating the difference between output and input VAT on every transaction.
| Eligibility | Limit |
|---|---|
| VAT-exclusive turnover | Up to £150,000 |
| First-year discount | 1% reduction in your flat rate for the first 12 months |
The scheme works well if your costs are low relative to your revenue – for example, consultants, IT contractors and professional services firms.
However, since April 2017, limited cost traders (businesses whose goods cost less than 2% of turnover or less than £1,000 per year) pay a flat rate of 16.5%, making the scheme less attractive for many service businesses. Check whether the standard scheme would save you more.
Cash Accounting Scheme
Under the Cash Accounting Scheme, you account for VAT when you receive or make payment, rather than when you issue or receive invoices. This helps with cash flow because you do not pay VAT on invoices that your customers have not yet paid.
| Eligibility | Limit |
|---|---|
| VAT-exclusive turnover | Up to £1.35 million |
| Must leave if turnover exceeds | £1.6 million |
This scheme is particularly useful for businesses that:
- Give customers credit terms (30, 60 or 90 days)
- Experience late payments from customers
- Want to align VAT payments with actual cash flow
Annual Accounting Scheme
The Annual Accounting Scheme lets you submit one VAT return per year instead of four, with interim payments based on your estimated liability. At the end of the year, you make a balancing payment or receive a refund.
| Eligibility | Limit |
|---|---|
| VAT-exclusive turnover | Up to £1.35 million |
The scheme reduces admin but removes the ability to reclaim VAT more frequently. If you are regularly in a repayment position (for example, an exporter), quarterly returns are better.
Combining Schemes
You can use the Flat Rate Scheme together with the Annual Accounting Scheme. You cannot combine the Flat Rate Scheme with the Cash Accounting Scheme (the Flat Rate Scheme already has its own cash-based element).
Reclaim VAT on Pre-Registration Purchases
When you register for VAT, you can reclaim input VAT on:
- Goods purchased up to 4 years before registration (provided they are still held or used in the business)
- Services purchased up to 6 months before registration
This includes stock, equipment, professional fees, software and other costs. Keep all receipts and invoices – you need valid VAT invoices to make the claim.
Get Your VAT Invoices Right
A valid VAT invoice must include:
| Element | Required? |
|---|---|
| Supplier’s name, address and VAT number | Yes |
| Customer’s name and address | Yes |
| Unique invoice number | Yes |
| Invoice date and tax point | Yes |
| Description of goods or services | Yes |
| Quantity and unit price (excluding VAT) | Yes |
| Rate of VAT and total VAT charged | Yes |
| Total amount including VAT | Yes |
For supplies under £250, a simplified VAT invoice is acceptable (showing the total including VAT and the VAT rate, but not the customer’s details).
Without a valid VAT invoice, HMRC can deny input VAT recovery. This is one of the most common reasons for adjustments during VAT inspections.
Understand Partial Exemption
If your business makes both taxable and exempt supplies, you are partially exempt and can only recover a proportion of your input VAT. The standard method is to apportion input VAT based on the ratio of taxable to total supplies.
You can ignore partial exemption (and recover all input VAT) if the exempt input VAT is:
- Under £625 per month on average, and
- Under 50% of total input VAT
This is the de minimis rule, and it simplifies things for businesses with only small amounts of exempt income (such as bank interest).
Time Your Purchases Carefully
VAT is based on the tax point – the earlier of when goods are delivered, when payment is received or when an invoice is issued. You can improve cash flow by:
- Timing large purchases to fall just after a VAT quarter ends, giving you almost a full quarter before you need to reclaim
- Issuing invoices promptly so output VAT is matched to the correct period
- Paying supplier invoices before the end of the quarter if using the Cash Accounting Scheme, to maximise your input VAT claim
Watch Out for Common Mistakes
| Mistake | Consequence |
|---|---|
| Claiming VAT on non-deductible items (client entertaining, cars for non-business use) | Assessments and penalties |
| Charging VAT on exempt supplies (insurance, education, some financial services) | Overpaying HMRC and overcharging customers |
| Not keeping valid VAT invoices | Input VAT denied on inspection |
| Missing the registration deadline | Backdated registration and VAT owed on past sales |
| Filing returns late | Points-based penalties under the new system |
| Not adjusting for credit notes | Overstating or understating VAT |
Keep Clean Records
Under Making Tax Digital, all VAT-registered businesses must keep digital records and submit returns through compatible software. This means:
- Every transaction must be recorded digitally (not in a paper cashbook)
- The digital link between records and the VAT return must not involve manual re-keying
- Records must include the time of supply, value and rate of VAT for each transaction
Maintaining clean, categorised records from the start makes VAT returns straightforward and reduces the risk of errors.
Review Your VAT Position Annually
At least once a year, review whether:
- You are on the best VAT scheme for your current turnover and cost profile
- Your flat rate percentage is still correct (it changes if your business activity changes)
- You are claiming all allowable input VAT
- Your partial exemption calculation is still correct
- You have reclaimed VAT on any bad debts (you can reclaim output VAT on debts outstanding for more than 6 months)