VAT for UK Freelancers: What You Need to Know

As a freelancer, understanding your tax obligations, including VAT (Value Added Tax), is crucial. VAT is a tax on goods and services added to the price of most products and services in the UK. While some businesses must register for VAT based on their annual turnover, others may be exempt.

VAT for Freelancers and Self-Employed: What You Need to Know

Basics of VAT

VAT, or Value Added Tax, is a tax applied to most goods and services sold by registered businesses in the UK. The standard VAT rate is 20%, requiring this addition to any invoices for taxable goods or services. However, certain products and services, like energy-saving items and sanitary products, enjoy reduced VAT rates. Additionally, some are entirely exempt, such as most financial and insurance services.

VAT Threshold and Registration:

If your annual turnover is below £85,000 (as of 2021/2022), VAT registration is not mandatory, though you may opt for it voluntarily. However, exceeding this threshold mandates VAT registration, making it essential to charge VAT on your goods and services. To register, you must create a Government Gateway account and submit an online VAT registration form available on the HMRC website. Upon approval, HMRC will issue a VAT registration certificate with your VAT number and registration date.

While VAT-registered entities must charge VAT and submit VAT returns to HMRC, it’s vital to understand that if you aren’t registered for VAT, you can’t charge or claim back any VAT. For those under the threshold but still registered, certain benefits can emerge, such as appearing more professional and claiming back VAT on specific expenses.

Advantages of Voluntary VAT Registration:

  • Reclaiming VAT:
    Even if your turnover is below the threshold, by being VAT registered, you can reclaim VAT on your business-related purchases. This can lead to significant savings, especially if you have substantial startup costs or regular VAT-able expenses.

  • Business Perception:
    Being VAT registered can enhance the perception of your business. Some larger companies and clients prefer or even expect to deal with VAT-registered businesses as it can make a business appear more established and credible.

  • Steady Preparation:
    If you anticipate that your turnover will surpass the threshold in the near future, registering early allows you to get used to the process of VAT accounting before it becomes mandatory.

  • Simplified Invoicing within the EU:
    If you’re supplying digital services to non-business consumers in the EU, VAT registration can simplify the invoicing process, as the VAT ‘Mini One Stop Shop’ (MOSS) scheme can be used.

Disadvantages of Voluntary VAT Registration:

  • Increased Administration:
    Being VAT registered means you’ll have to keep detailed records and submit regular VAT returns, which can add to your administrative burden.

  • Potential Pricing Issues:
    If your target audience is primarily individuals who can’t reclaim VAT or small businesses not registered for VAT, they effectively bear the cost of the VAT, making your prices less competitive.

  • Regular Reporting:
    There’s a commitment to regular reporting, and failing to submit returns and payments on time can lead to penalties. This can be stressful for small businesses without dedicated accounting resources.

  • Cost Implication:
    There may be additional costs involved, such as accounting software or hiring an accountant to ensure accurate VAT recording and reporting.

Different VAT Schemes:

There are several VAT schemes tailored to simplify VAT processes for businesses:

Standard VAT Accounting:

This is the most common VAT scheme. Under it, businesses charge VAT on their sales (known as ‘output tax’) and reclaim VAT on their purchases (known as ‘input tax’). The business then pays HMRC the difference between these amounts.

Pros:

  • Flexibility in reclaiming VAT on purchases even if the invoice hasn’t been paid.
  • Regular interaction with VAT processes can help businesses stay on top of records.

Cons:

  • Requires detailed record keeping.
  • Can lead to cash flow issues, as VAT might need to be paid to HMRC before clients have settled their invoices.

Suitability for Freelancers:
Ideal for freelancers with regular clients and consistent cash flow.

Flat Rate VAT Scheme:

This scheme lets businesses pay a fixed rate of VAT to HMRC. They keep the difference between the VAT they charge customers and the VAT they pay to HMRC but cannot reclaim VAT on purchases.

Pros:

  • Simplified accounting and less time spent on paperwork.
  • Predictable VAT costs.

Cons:

  • Can’t reclaim VAT on purchases.
  • Might end up paying more VAT than with the standard scheme.

Suitability for Freelancers:
Best for freelancers with minimal VAT-able expenses.

VAT Cash Accounting Scheme:

Businesses account for VAT on sales when they get paid and reclaim VAT on their purchases when they pay their suppliers.

Pros:

  • Improved cash flow, as VAT is only due once the client pays.
  • Simplifies the relationship between cash flow and VAT.

Cons:

  • Can’t reclaim VAT on purchases until you’ve paid the supplier.

Suitability for Freelancers:
Ideal for freelancers who might experience irregular payments or delays from clients.

VAT Annual Accounting Scheme:

Businesses make advance VAT payments towards their bill. They then only submit one VAT return at the end of the year.

Pros:

  • Reduces paperwork and administrative time.
  • Offers certainty with regular fixed payments.

Cons:

  • Reduced frequency might lead to overlooking VAT responsibilities.
  • If turnover decreases, businesses might overpay and will need to wait for a refund.

Suitability for Freelancers:
Suitable for freelancers who want to reduce administrative burdens and prefer predictable payments.

Calculating and Paying VAT

Calculating VAT

It’s imperative to charge the correct VAT rate. The standard UK rate is 20%, but some goods and services fall under 5% or 0% rates. After charging VAT, deduct any VAT paid on business expenses, known as input tax. The difference between the VAT charged (output tax) and VAT paid (input tax) determines your VAT payment to HMRC.

There are many VAT calculators available online, some of which are free to use:

For example:

Record Keeping:

Maintaining accurate VAT records is not just a good business practice—it’s a legal requirement for VAT-registered businesses. The significance lies in:

  • Ensuring Compliance:
    HMRC can request to see your records to verify that you’re paying the correct amount of VAT. Accurate record-keeping ensures you remain compliant and can provide the necessary documentation when required.

  • Avoiding Penalties:
    Mistakes in your VAT calculations due to inaccurate records can lead to underpaying or overpaying VAT. Either scenario can result in penalties or interest charges from HMRC.

  • Financial Clarity:
    Keeping precise records helps you understand your financial situation, enabling more informed business decisions.

  • Efficient Audits:
    If your business is subject to an audit, having clear and accurate VAT records will simplify the process and reduce the risk of complications

What Records Need to be Kept:

  • Sales and Purchase Invoices:
    These must detail the VAT charged, the rate at which it’s charged, and the total amount excluding VAT.

  • Import and Export Documentation:
    If you’re trading outside the UK, it’s crucial to have documentation that provides details of goods and services bought or sold and the VAT paid or reclaimed.

  • VAT Account:
    A summary of output tax owed to HMRC and input tax you’re entitled to reclaim, as well as any VAT that you owe or are owed by HMRC.

  • Bank Statements:
    These help cross-reference transactions and ensure that all VAT has been accounted for.

  • All Digital Sales Records:
    For businesses using digital platforms or selling digital services, records of all transactions, rates applied, and amounts charged need to be kept.
  • Credit or Debit Notes:
    Any changes to a VAT invoice should be documented.

All VAT records should be kept for a minimum of six years. However, if your records relate to items of equipment, machinery, or business property that you use over a longer period, you should keep these records for six years from the last date you used them.

VAT Returns and Payments:

Most businesses in the UK are required to submit a VAT return to HMRC every three months. This period is known as your ‘VAT accounting period’. The specific dates of your VAT accounting periods will be provided when you register for VAT, but they typically follow the quarters of the financial year. Some businesses may be on the VAT Annual Accounting Scheme, where they only need to submit one return a year.

How to Calculate the Amount Owed:

To determine the amount of VAT owed, businesses should follow these steps:

  • Determine Output Tax:
    This is the VAT you charge on your taxable sales. Sum the VAT for all taxable sales made during your VAT accounting period.

  • Determine Input Tax:
    This is the VAT you’ve been charged on your business-related purchases. Sum the VAT for all business expenses and purchases during your VAT accounting period.

  • Subtract Input Tax from Output Tax:
    If your output tax is greater than your input tax, the difference is what you owe HMRC. If your input tax is greater than your output tax, you may be eligible for a VAT refund.

Deadlines and Penalties:

  • Submission Deadlines: Typically, your VAT return must be submitted, and any VAT owed paid, one month and seven days after the end of your VAT accounting period. For instance, for a VAT period ending on March 31, the deadline would be May 7.

  • Payment Deadlines: The same deadline for submitting the VAT return typically applies for payment. This ensures that HMRC receives the owed amount by the specified date. Methods like Direct Debit might give a few extra days.

  • Penalties: If you fail to submit your VAT return or pay on time, you might enter the ‘surcharge period’. This lasts for 12 months, and if you’re late again during this period, you may have to pay a surcharge. The surcharge is a percentage of the VAT outstanding and unpaid by the due date. The percentage increases each time you’re late during the surcharge period. There can also be penalties for errors in the VAT return, depending on whether HMRC believes the mistake was careless, deliberate, or concealed.

What Freelancers Can and Cannot Claim Back:

Can Claim:

  • Business Equipment:
    If a freelancer purchases equipment solely for the business, such as a computer or camera, they can typically claim the VAT back.

  • Office Supplies:
    Stationery, printer ink, and other necessary supplies for the business.

  • Travel Expenses:
    VAT on fuel, train tickets, and other travel-related expenses for business purposes can be reclaimed. However, if it’s a mix of personal and business travel, only the business portion can be claimed.

  • Business Premises:
    If renting a space solely for business, the VAT on rent might be reclaimable.

  • Professional Services:
    VAT charged by accountants, consultants, and other professionals engaged for business needs.

Cannot Claim:

  • Entertainment:
    Costs related to entertaining clients, such as meals or event tickets, usually aren’t eligible for VAT reclaim.

  • Purchases for Personal Use:
    Any equipment or service purchased for personal use, even if occasionally used for business, typically can’t have its VAT reclaimed.

  • Exempt Supplies:
    VAT can’t be reclaimed on items or services that are VAT-exempt, like certain types of training or insurance.

  • Non-VAT Registered Purchases:
    If a freelancer purchases goods or services from a non-VAT registered entity, there’s no VAT to reclaim.

I hope you found this article useful, but seriously, my advice would be to get VAT registered, be sure to keep all your receipts but hire an accountant to do all the leg work for you. You have far more important things to be doing with your time than VAT returns.
Dave Ashworth
Dave Ashworth

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