Most limited company contractors are VAT registered. Here we look at what your obligations are, and how VAT accounting works in practice.
When must you register for VAT?
If your company turnover is £85,000 or greater (or is likely to reach this threshold over the next 12 months), you must compulsory register for VAT (2017/18 tax year).
Given the nature of contracting, almost all contractors register for VAT regardless of turnover. You company simply acts as a ‘tax collector’ on behalf of HMRC. You add VAT (at the prevailing 20% rate) to all your invoices to clients / agencies, and you can reclaim the VAT your company has paid on eligible company expenses.
Under the standard VAT scheme, you need to submit an electronic quarterly return to HMRC, detailing the total VAT charged and reclaimed by your company. You also have to pay the outstanding VAT to HMRC electronically each quarter (we recommend you set up a direct debit to ensure you don’t miss the deadline).
VAT schemes for limited companies
Depending on your own situation, your company will typically join the Flat Rate VAT scheme, or the standard scheme. In both cases, you charge the standard rate of VAT on invoices to clients (currently 20%).
The Flat Rate scheme was designed to simplify VAT calculations for smaller businesses, and allows you to pay a flat rate of tax each quarter, using a percentage associated with your profession or industry. For most contractors, the current percentage is 14.5%, although during your first year on the scheme, you benefit from a 1% reduction to 13.5%.
Whether or not you are likely to benefit from joining the Flat Rate scheme will usually depend on the amount of expenses you are likely to reclaim during a year. If the amount is high, you may be better off on the standard scheme. Your accountant should be able to advise you which scheme will be most beneficial to your company.
If you set up a limited company for contracting, your accountant will typically register your company for VAT as a primary administrative tasks. HMRC provides various different VAT schemes – and the Flat Rate scheme may actually save you money.
If you’re not on the Flat Rate VAT Scheme, you may decide to join the Cash Accounting Scheme – this allows you to account for VAT once you have received payment for your invoices… rather than at the time when you create an invoice. Clearly, there are cashflow benefits to doing this. There is not formal need to inform HMRC if you are doing this, but you should start of any given VAT quarter. Ask your accountant for further advice.
Flat Rate VAT scheme
The FRS was put in place to simplify accounting for small enterprises. Rather than accounting for VAT in the standard way detailed above, you simply pay a fixed percentage of turnover to HMRC each quarter. The percentage you use in calculations depends on your industry sector.
Here are the key points you need to know when considering the type of VAT scheme to register for.
- For IT contractors, the flat rate percentage used in calculations is 14.5%
- For your first 12 months trading, you also benefit from a 1% reduction in the fixed percentage to 13.5%.
- You can join the scheme if your annual turnover is £150,000 or less, and if it increases over time, you don’t need to leave the scheme until your turnover reaches the £230,000 mark.
- Under the FRS, you do not need to account for all your individual transactions.
- You still need to invoice clients as usual, using the standard rate of VAT.
- Most IT contractors are likely to benefit if they don’t make a lot of VAT-able purchases.
- You can still reclaim the cost of large purchases – those worth £2,000 or more (in a single transaction).
- Find out more in HMRC’s guide to the FRS, including information on how to calculate your tax liabilities under the scheme.
You should discuss the advantages and disadvantages of your individual company joining the FRS with your accountant.
Try our overview of the other taxes you are likely to encounter as a limited company owner.