VAT stands for Value Added Tax. It’s a type of UK consumption tax applied to the value added at each part of the production and sale of goods and services. In simple terms, it’s extra money added on top of the making and selling of things, which the government then collects and reinvests.
The standard VAT rate is 20% and this applies to most qualifying goods and services, although some things like sanitary products, financial services and children’s clothing have reduced (5%) or no (0%) VAT applied.
The end customer is the one that ultimately pays VAT but as you know, even as a business owner, sometimes you’re also the customer.
How does VAT work for freelancers?
Here are some key things to know about VAT as a freelancer:
- VAT works the same for freelancers as it does for any other type of contractor or business owner. Registration is only mandatory once your VAT taxable turnover reaches a certain threshold.
- You only need to charge VAT as a freelancer if you are VAT-registered
- Once you are registered for VAT, you will need to start adding VAT to your client’s invoices and submit VAT Returns to HMRC
Do all freelancers have to register for VAT?
No, not all freelancers will need to register for VAT. As with all types of business owners, you only need to register for VAT once your VAT taxable turnover (the total amount of sales you make of anything that isn’t exempt from VAT) exceeds the legal threshold.
The VAT threshold is currently set at £90,000. So, if your VAT taxable turnover is over this amount, you will need to register for VAT by law. The registration deadline is within 30 days from the end of the month in which you exceeded the threshold.
As long as your taxable turnover is under this threshold, you won’t need to worry about registering for VAT or charging your clients VAT. However, some people choose to register for VAT voluntarily.
Voluntary VAT registration
Unless you only sell goods or services that are VAT-exempt or zero-rated, you can voluntarily register for VAT, even if your taxable turnover is nowhere near the £90,000 threshold yet.
The benefits of registering for VAT voluntarily include:
- Making savings as you can reclaim VAT on business-related purchases. In some cases these can also be backdated for up to four years prior to your VAT registration date.
- Making your business appear more established and therefore more credible in your clients’ eyes.
- Making some types of EU invoicing easier.
- Eliminating the need for you to do it at a later date when your business will be bigger and you’ll be busier.
- Mitigating the risk of exceeding the legal VAT registration threshold without realising.
If you fail to register for VAT once it becomes mandatory, you risk being slapped with a financial penalty of between 5-15% of what you owe on top of the outstanding tax. If you think you’re going to pass this point within the next 30 days, it’s time to get VAT-registered, pronto!
Just be aware that:
- You’ll have more admin to do as you’ll need to account for VAT on your invoices and in your bookkeeping, and submit VAT Returns to HMRC.
- VAT registration can affect your pricing structure. Because it’s an added charge, you might decide to pass this on to your customers (so the amount they pay is higher), pay it yourself (which will eat into your profits), or a combination of both.
It’s important to note that if you aren’t registered for VAT, you aren’t allowed to charge or claim back any VAT.
Once you’re registered, whether it’s voluntarily or mandatory, you will need to start charging VAT on your goods and services.
The different VAT schemes
If and when you do register for VAT as a freelancer, you’ll need to understand the various schemes so you can choose how to charge, claim and report VAT in a way that suits you. These include:
- Standard VAT accounting scheme
- VAT Flat Rate Scheme
- VAT Cash Accounting Scheme
- VAT Annual Accounting Scheme
- VAT retail schemes
- VAT margin schemes
Let’s explore four of the most common schemes to help give you an idea of how each one works.
Standard VAT
The Standard VAT scheme is a great option if your cash flow is healthy and you have regular clients who are reliable payers.
Using this scheme, you charge VAT to your customers (output tax) and reclaim VAT on your purchases (input tax). You then pay HMRC the difference between these two amounts as part of your VAT Return, even if your customers haven’t paid you yet.
Flat Rate VAT
As the name suggests, this scheme is where you pay a flat rate of VAT to HMRC as a percentage of your turnover, as opposed to calculating the difference between output tax and input tax like you do with the Standard VAT scheme.
Once the flat rate is paid, you get to keep the difference between what you charge your clients in VAT and what you pay HMRC. For some business owners, this scheme is preferable because it’s quicker and easier than calculating specific amounts.
However, with the Flat Rate scheme, you aren’t allowed to reclaim VAT on your purchases. This scheme is good if you want something predictable and standardised or if you don’t typically pay much (or any) VAT on the things your business buys.
VAT Cash Accounting
Cash Accounting might make the most sense for you if your freelance clients aren’t regular or if your clients are notoriously bad at paying their invoices on time.
With this scheme, you account for the VAT on sales and purchases when the payment happens, rather than using the date of the invoice. This means you don’t need to pay the VAT you collect from a customer until they actually pay it, but likewise cannot claim the VAT you owe to a supplier until you pay them.
VAT Annual Accounting
VAT Annual Accounting is where you make advance payments towards your next VAT bill during the year, either on a monthly or quarterly basis, and then submit an annual return. You can request a refund from HMRC if the advance payments result in an overpayment.
The key thing to consider about the Annual Accounting VAT scheme is that you can only reclaim VAT on an annual basis. So, although it is one of the simpler methods, reclaiming on a yearly basis might not work for you (or your cash flow).
How do I add VAT to my freelance costs?
To charge your freelance clients VAT, you’ll need to figure out which VAT rates apply to your goods or services. Once you know this, you can then add this to your original costs on your invoices.
For example, if you charge a freelance client a £500 day rate and want to add VAT at the standard 20% rate, you’ll invoice them £600 in total. This is the £500 day rate plus 20% VAT (£100).
On your invoices, you should detail:
- The original cost (the price excluding VAT)
- The VAT rate (% amount) being applied
- The total (original cost plus VAT)
- Your VAT number
When discussing your prices with clients or displaying them on your website, make sure to communicate clearly that you charge VAT on top of your standard costs.
Remember to keep excellent records of all your financial transactions, and to record your VAT dealings in detail!
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