Many tradespeople have questions about VAT and what it can mean for their business. Carl Goulding, MyBuilder’s head of trade quality and a veteran tradesman, shares his advice.
A no-bull view on VAT for domestic tradespeople
There is no one-size-fits-all advice when it comes to VAT registration. In my experience, a lot of builders will work pretty hard to avoid ever hitting the VAT ceiling by never taking on enough work to reach the threshold at all, which works pretty well for many who just want to earn a living in peace.
However, if your plans are to build a business in construction, VAT registration is something you will be faced with sooner rather than later. So what is VAT? what are the rules? and how can it work for you?
Put simply, VAT is just a sales tax. In the UK right now, VAT stands at 20% and the threshold at which VAT registration becomes mandatory is £85,000. This means that if the sum of all invoices you send your customers over any 12 month period equals £85k or more then you have no choice but to register for VAT. Bear in mind this is not £85k at the end of your accounting year, this is £85k during any 12 month period. So, if you want to know how close you are to hitting the VAT ceiling, start with today’s invoices and go back 12 months, adding everything up as you go. If you are well below £85k then happy days, you can go do something more interesting than reading about VAT, like watching paint dry. But, if the figure you arrive at is £85k or more then you should have registered for VAT already. If the number is getting close to £85k then you have a choice to make in the near future. Either stop working until you have some headroom or, start thinking about registering for VAT.
The pros and cons of VAT registration
There’s no denying that VAT can be confusing and the extra admin can be a pain in the backside, but hands down the biggest downside to VAT registration is becoming more expensive. This is unavoidable because you now have to add 20% to every penny you charge your customers in order to fulfill your new role as an unpaid tax collector for HMRC. It’s not all doom and gloom however - there are some perks to being VAT registered; reclaiming 20% VAT on fuel always made me smile.
So the way I see it is, if you decide to register for VAT, ignoring reclaiming VAT for a minute, you now have two choices for how to handle your pricing going forwards. This choice really depends on the health of your business.
Your first option is technically the “correct” one and relies on you changing how you price your jobs altogether. It’s a method where you discount all expenses to their VAT exclusive price. Let’s say you have a painting job and are supplying the paint. The paint costs £12 from your local supplier (let’s call this £10 + VAT). As a non-VAT registered business you would purchase the paint for £12 and charge it out at £12 to your customer. As a VAT registered business however, you would instead charge the pot of paint out to your customer at £10 + VAT. Then when VAT is added the pot of paint becomes £12 again. You and your non-VAT registered competitors still both charge £12 for the paint and your customer is none the wiser. The downside however, is that you also have to add VAT to your labour costs which of course may make you more expensive overall, just not by a whole 20%.
Your second option requires your business to cope with raising your prices further. For this option you continue to price everything as you did as a non-VAT registered business and then simply add 20% to your total at the end. That same pot of paint you purchase for £12 before, you now resell for £12 + VAT meaning it costs your customer £14.40, earning you a little profit. This worked really well for me when I crossed the VAT threshold. I had been wanting to raise my prices for a while, but with lots of repeat customers I felt stuck, as I didn’t want them to think I was simply raising prices on them. By using VAT registration to effectively mask a price rise I was able to cross the threshold and raise my underlying prices too.
In either case you will need to raise your prices, the question is by how much. Only you know how desirable your services are and how much people will pay. On the plus side of VAT registration though, you can start reclaiming the VAT you have input in to the system. Here, you will start to reduce the VAT bills that start arriving, and this is where some of the perks are hiding.
“Reclaiming” VAT vs “reducing” your VAT bill.
So the way VAT works is that you add 20% to every penny you charge your customers. If you want to charge someone £100, then this becomes £100 + VAT (£120 in total) and in this case the VAT man will want £20 from you. You must hand over to HMRC any VAT you collect, no questions asked. Now let’s say that to earn this £100 you painted a room and that £12 pot of paint was needed to do the job. Because you paid £10 + VAT for it you have already paid £2 VAT to the VAT man through the supplier. You are therefore allowed to reduce your £20 VAT bill by £2. Your VAT bill is now £18. But what about the £10 you spent on fuel getting to and from the job? Well you can also reclaim the £1.66 VAT on that too bringing what you owe the VAT man down to £16.34 which is not bad considering you took £20 off the customer. Did you buy any tools or van insurance, clothing, etc? Well this is all reclaimable too (though the rate can vary on different expenses).
The effect of this “reclaiming” of VAT is not really money paid back to you, it’s more a reduction of what you owe the VAT man from your tax collection efforts. You collected the VAT from your customer and then get to reduce what you hand over to HMRC by offsetting what you spent on VAT while doing the work. This adds up over time and can make many of the things you wish to purchase for your business that little bit (20% currently) cheaper. This is when you have a real advantage over your non-VAT registered competitors because that van you want to buy for £8,000 + VAT now only costs you £8,000 because you can reduce the VAT from your VAT bill, whereas it will cost them £9,600 for the same van.
The new VAT rules from October 1st 2019 - The reverse charge explained
VAT has changed. As of October 1st 2019 HMRC have decided to make administering VAT for those at the top of the food chain a little harder. This will really only affect the VAT registered contractors who use VAT registered subcontractors.
Before the rule changes, if you asked Steve, your VAT registered electrician friend to install a new light, he may charge you £100 + VAT. You then pay Steve £120 inc. VAT. Steve then pays the £20 VAT he charged you to HMRC. You then claim to reduce your own VAT bill by the £20 VAT Steve invoiced you for. Not hugely simple, but not rocket science either.
Now, using the same scenario but under the new rules, Steve would still bill you £100 + VAT but you would only need to pay Steve £100 of it. You would be required by HMRC to give the £20 VAT billed by Steve straight to them instead. If you operate under CIS then this will make sense as it’s the same principle of stopping income tax. This basically means that you are responsible for handing over the VAT of any of the subcontractors you use to HMRC instead of paying it to the subbies themselves to pay to the VAT man. Still not hugely complex but a little bit more to account for each month, which is great, right?
Managing VAT can be painful. You could of course choose to manage it all yourself, and I will soon write a little on managing and scaling a building company; but for now, my recommendation is to get a good accountant to deal with it all for you, so you can focus on doing what you do best.
Rates and thresholds mentioned in this article are correct as of November 2019