Contractors Guide to VAT
Introduction to VAT for Contractors
VAT is a “sales” tax that is controlled and collected by HMRC (HM Revenue & Customs).
If you are a contractor working for an umbrella company then you do not need to worry about VAT. The umbrella company will calculate VAT on invoices and pay the necessary amounts due to HMRC.
If you use a limited company/personal service company and expect to have turnover of more than £71,000 per annum, you should register for VAT. This simply means that you collect VAT on behalf of HMRC on sales invoices and must account for this and ensure the correct amounts are paid over to HMRC. Registration for VAT takes between 6 – 12 weeks.
Each quarter, HMRC will send you a green VAT return for completion. All VAT received on your sales invoices minus VAT paid on legitimate company expenses should be paid over to HMRC. VAT is currently 20% on most items although some things are zero rated or low rated at 5% (although this is mostly essential items such as staple foods or things like kid’s clothes).
There is also the concept of the Flat Rate scheme to help simplify the process and you need to decide which method to use when applying for VAT.
The VAT Flat Rate Scheme
Using standard VAT accounting, the VAT you pay to HMRC or claim back from them is the difference between the VAT you charge your customers and the VAT you pay on your purchases.
Using the Flat Rate Scheme however, you pay VAT as a fixed percentage of your VAT inclusive turnover.
The actual percentage you use depends on your type of business.
You can join the Flat Rate Scheme for VAT and so pay VAT as a flat rate percentage of your turnover if your estimated VAT taxable turnover – excluding VAT – in the next year will be £150,000 or less.
Your VAT taxable turnover is the total of everything that you sell during the year that is liable for VAT. It includes standard, reduced rate or zero rate sales or other supplies, however, it excludes the actual VAT that you charge as well as VAT exempt sales and sales of any capital assets.
Under the Flat Rate Scheme you generally don’t reclaim any of the VAT that you pay on purchases, although you may be able to claim back the VAT on capital assets worth more than £2,000.
Once you join the scheme you can stay in it until your total business income is more than £230,000 excluding VAT.
You can calculate (and repay) VAT on a cash or accruals basis – i.e. based on when you receive VAT from your invoices, or based on invoices sent during the VAT quarter for which you may or may not yet have received payment. An accountant will advise you which method is best for you.
And it’s pretty easy to calculate how much VAT you should be adding to your invoices if you are contracting via your own limited company. All you have to do is multiply the original (‘net’) price for your service by the VAT rate (20%) in order to work this out. Then add this amount to the net price to give you the ‘gross’ price – the price your client will pay.
If you are a contractor using an agency on a PAYE basis then the agency will be responsible for all VAT processes.