Understanding VAT for Limited Company Directors

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VAT is the general sales tax applied across the European Union. Businesses supplying goods or services with a turnover above £80,000 per year are required to collect this tax from their clients and pay it to HMRC on a quarterly basis. Registering for VAT also means that you can reclaim VAT from expenses you incur in running your company (this is why you will see prices for business services such as accountancy excluding VAT).

Charging VAT

When you register for VAT (your accountant can usually do this for you) you will receive a VAT number. This should be shown on all of your invoices as it allows your client to reclaim the VAT on their own return if they are eligible. For most goods and services in the UK VAT should be charged at 20%. Your invoice should itemise this, for example:

20 days @ £500 per day = £10,000

VAT @ 20%                       = £2,000

Total Including VAT          = £12,000

This makes it easier both for the client and your own accountant to account for the VAT. You should charge VAT on each invoice, but will only submit a VAT return and pay HMRC on a quarterly basis. As mentioned above there will probably be some deductions from the amount you need to pay, however best practice is to treat the entire amount of VAT (in the example above £2,000) as being due to HMRC. When your accountant then calculates your VAT liability there will be more than enough money in the company to pay your bill, the excess then becomes a part of your company’s profits.

Paying VAT

There are two methods for your company to account for VAT, “Standard Basis” and the “Flat Rate Scheme (FRS)”. Whilst it is possible to do your own VAT filings, most monthly accountancy packages include processing this, so it is easiest to let your accountant handle this.

Standard Basis

On Standard Basis VAT, the amount due for Payment to HMRC is the total amount of VAT you have charged clients, less the VAT from expenses that your company incurred (e.g. accountancy and insurance). For example if the invoice from the example above represented your invoice in all 3 months of the quarter you would have collected £6,000 in VAT. If the VAT from your expenses over the quarter came to £750, you would need to pay HMRC £5,250.

If you are accounting for VAT on the Standard Basis it is important that you obtain and keep VAT receipts for all of your expenses, as these will be required to evidence your deductions in the event of an HMRC audit.

Flat Rate Scheme

The Flat Rate Scheme was introduced to simplify the administration of VAT for small businesses. Rather than calculating the total VAT to be deducted from each quarter’s VAT payment, on the FRS a company can simply pay a fixed percentage of their gross (i.e. including VAT) turnover each quarter. The rates vary depending on the nature of your business, however the overwhelming majority of contractors are classed as “limited costs traders” and therefore use a rate of 16.5%. This means that, in our example you will have invoiced £36,000 including VAT over the quarter and will need to pay 16.5% of this amount to HMRC, this comes to £5,940.

As you can see from the examples above, the Standard Basis gives a saving over the FRS, however it involves more administration in the form of keeping receipts and records. Ultimately the decision of which method is best varies for each company. Make sure you discuss with your accountant which is best for you.

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