Study Zone

Navigating the VAT maze

When must a new business register for VAT? And when and why do businesses voluntarily register? We explain some of the mysteries that surround VAT

There are two main registration tests to consider when surrounding VAT registration, often referred to as the 'historic' and 'future' tests.

The historic test
This test must be checked by a business at the end of every month, and says that a business that is not VAT registered must add up the total of its taxable supplies in the last 12 months. Two important things to note are that, firstly, taxable supplies includes zero rated sales but not exempt sales and, secondly, it is important to realise that the test is carried out every month even though in the first year of trading there are obviously less than 12 months of sales to consider. If the total taxable sales exceeds £64,000 (FA07), then the business has broken the registration threshold. The business then has 30 days to notify HMRC. It is technically effective from the end of the month after when the threshold was broken (or earlier by agreement). However, note that the end of the month is midnight and hence in effect the first invoice with VAT will be dated the 1st.
Example: If the threshold is broken at 30 November, then you have until 30 December to notify HMRC. However, it is effective from the end of the month after the threshold is broken, namely
31 December at midnight so the first invoice showing VAT will be dated 1 January. In effect, you get an extra month from when you first break the threshold before having to charge VAT.

The future test
This test considers what your expected turnover is at any point in time over the next 30 days; if your expectation is for taxable sales over £64,000 in the next 30 days then you are caught. If caught by the future test you still have 30 days to notify HMRC but it is effective immediately and hence you must immediately charge VAT on all your future sales. It is important to realise that being caught by the future test is relatively unusual because it means sales in the next 30 days are expected to exceed £64K but sales in the whole of the last 12 months have not exceeded this figure (otherwise the historic test would generally apply). A common error of students is to incorrectly combine these two tests and, for example, add the next 30 days onto the last 12 months turnover and compare to the registration limits. This is clearly wrong.
Impact of registration
The effect of registration is that you must begin to charge VAT at the appropriate rate on your taxable supplies. On the plus side, you can now recover VAT on your purchases used to make taxable supplies.

Pre registration expenses
Once registered, a business is allowed to recover VAT on certain expenses incurred prior to being registered as follows:
1) Stock unsold at registration (bought in last three years).
2) Fixed assets bought in last three years and in use at registration.
3) Services supplied in the last six months.
The logic of this rule is that these previously purchased items are now being used to make taxable supplies and hence fairness says the VAT should be recoverable. Take for example the stock; when it was bought VAT was paid to the supplier and was not recoverable as being unregistered no VAT would be charged on its onward supply. However, as the business is now VAT registered, then if the stock is sold now VAT must be charged and hence it is only fair that the VAT previously paid to the supplier is now recoverable.
Voluntary registration
Generally, any business that makes taxable supplies may register for VAT if it wishes and there are several reasons why a business may choose to do this and below I've identified a few:
Image: Not being registered tells the world your turnover is below £64,000 so some businesses choose to register so as to give the impression they are bigger than they actually are.
Input VAT recovery: Being VAT registered means that you can recover your input VAT while this seems attractive you need to consider the effect on your customers. If you make zero rated sales then there will be no change in your prices for your customers but you can recover your input VAT thus reducing your costs (clearly a good thing). Alternatively if your customers are VAT registered and can recover any VAT charged then they should not be concerned if you become VAT registered and increase your prices by 17.5%.
Recovery of pre registration VAT: As noted above certain amounts of VAT incurred pre registration can be recovered and hence it may make sense to register early if for example a large piece of capital was purchased around three years ago.
Penalty avoidance: If you know that you will shortly be required to be VAT registered then it may make sense to register early to get it all sorted out at a time convenient to you and avoid any possibility of late registration penalties.
Obviously, any business choosing to be voluntarily registered should consider the added compliance burden of being VAT registered.
* Thanks go to CAMS College

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