Are you in low paid self-employment and considering becoming VAT registered?
Are you a courier, delivery driver, taxi driver or something similar? You may have heard that you can charge more for your services if you voluntarily register for VAT or that you can bolster your earnings under the Flat Rate VAT scheme. But VAT is a complex tax – any ‘benefits’ there are of entering the VAT regime can be totally wiped out by accountancy fees or penalties for getting things wrong. Voluntarily entering the VAT regime is therefore not something to be undertaken lightly – especially if it’s only a short term or seasonal role!
Recently, we have seen some job adverts where the payment rate is quoted as an amount inclusive of VAT, for example for a delivery driver for £150 per day including VAT.
This is quite confusing and if you want to apply for such a job, you may have some questions in your mind. Does it mean the true payment rate is £150 or something else? Will you get to keep the full amount in your pocket? Do you have to be VAT registered to claim the £150 payment rate? Why does the job advert assume you will already be VAT registered? Is the job advert just trying to disguise an otherwise lower payment rate?
Here we try to answer all these questions and provide further guidance on VAT for low-income workers.
What is VAT?
VAT is charged on the supply of goods and services by businesses (or people in business on their own account) who are VAT registered. Each VAT registered person in a supply chain between the first supplier and the final consumer, charges VAT on taxable supplies made by them (usually at 20%). If VAT is charged on taxable supplies made to them (usually at 20%) then the difference between the VAT they pay out on supplies and the VAT they receive from their customers is paid over to HMRC.
Johnny is a VAT registered carpenter. He pays £40 plus VAT (£48 in total) on some wood that he buys from a VAT registered business. He makes this into a table, which he sells for £120 plus VAT, so £144 in total. The VAT that he needs to pay to HMRC is calculated as follows:
Johnny sold his table for £144, which included £24 of VAT. The wood he bought to make the table was £48, which included £8 of VAT. So Johnny has received £24 VAT from his customer but from that he can deduct the £8 he incurred on costs and so £16 is payable to HMRC.
Put another way, of the £144 that Johnny received from his customer, he gets to keep £128. £48 of this represents Johnny’s costs, so his actual profit is £80. The £16 VAT payable to HMRC is therefore a tax (at 20%) on the £80 value added by Johnny (hence the name Value Added Tax).
We have produced a simple image (below) which may help to explain this further. There is also some basic guidance on VAT on the page Do I have to pay VAT if I am self-employed?.
You must register for VAT if your business’ taxable turnover (i.e. total income from taxable supplies) is more than £85,000 in any 12 month period, although there are other circumstances when you have to register for VAT.
Most people reading this, in business on their own account, will have total income well below the VAT registration threshold and are therefore not required to register for VAT. If you are not registered for VAT, it means that you do not charge VAT on your supplies (output tax) and you cannot reclaim the VAT paid on your expenses (input tax).
However you can get tax relief for your VAT inclusive costs by claiming the full amount you have paid as an expense in your self-employed accounts for income tax purposes. So, using the Johnny example, if he was not VAT registered, he would be able to take a deduction against his income of £48 for the wood he bought, rather than just the £40. If he was a basic rate taxpayer, this would save him £1.60. So although he can’t claim the actual VAT back on the wood (£8), he has saved £1.60 in income tax, so it has only really cost him £6.40.
If you are not VAT registered, we assume that the delivery company (referred to above) offering their new drivers a rate of £150 including VAT, would only expect to get an invoice from you of £125 per day, being the amount before VAT is added. If you are VAT registered then you could invoice them for the full amount of £150 (that is £125 + VAT of £25) but you should remember that you will need to pay some or all of the ‘extra’ £25 to HMRC!
Voluntary registration and the Flat Rate VAT scheme
You can choose to register for VAT voluntarily, that is, even if your income is not over the VAT registration threshold. If you also register for the simplified VAT scheme known as the Flat Rate Scheme (FRS), this, perhaps counter intuitively, can sometimes mean that some businesses can end up ‘in pocket’, depending on the nature of the business itself.
Under the FRS, a business charges VAT on its taxable supplies at 20% as usual but instead of paying over this ‘output tax’ less any recoverable ‘input tax’, the business pays over a flat rate percentage of the total (VAT inclusive) amount received from the customer. If this is, say, 10%, (the flat rate for transport) then the business gets to keep of the rest of the VAT they have collected for themselves. This is theoretically to compensate them for input tax that they have suffered on buying in goods or services in the course of their business, but often, small businesses will not have suffered much actual input tax.
Dave and Roshan are self-employed delivery drivers. Dave is voluntary registered for VAT under the FRS; Roshan is not registered for VAT. The flat rate percentage for ‘Transport or storage, including couriers, freight, removals and taxis’ is 10% (although it is possible to get a 1% discount on the usual rate in the first year of a VAT-registered business).
Roshan invoices the delivery company for the agreed rate of £125. Dave invoices the delivery company for the £125 rate plus VAT to make £150 in total. The flat rate for his delivery business is 10%, so the amount he needs to pay to HMRC is 10% of £150, or £15. Of the £150 that Dave receives from the delivery company, he therefore gets to keep £135 – or £10 more than Roshan.
Say Dave has only spent the equivalent of £5 per day on actual ‘input tax’ (for example, VAT on petrol that he has bought for his own van), he will ‘make’ £5 a day by being in the FRS. The FRS scheme can therefore sometimes be of benefit, essentially offering a small amount of additional income for a worker.
However in April 2017, new rules were introduced whereby a self-employed business which has very little input tax (because it does not have many expenses) has to apply a rate of 16.5% under the FRS and not the rate for its particular business sector. If Dave fell into this category (known as a limited cost business) then he would need to pay HMRC 16.5% of £150 or £24.75.
As such, there would be virtually no benefit in being in the FRS – or indeed being voluntarily VAT registered at all. This would be something for Dave to watch out for if his delivery company paid for all his petrol and van lease for example.
The existence of the FRS means that in some circumstances, your earnings are essentially being topped up by the Exchequer. It has to be said that this is not exactly how the FRS was intended to be used (and this is one reason for the introduction of the limited cost business rules mentioned above). In addition, as with most things in the tax world, there is a BIG catch….
If you register for VAT, even voluntarily, you are obliged to keep very good records of your income and expenses, complete regular VAT returns (unless you use something like the annual accounting scheme), and make regular payments of VAT to HMRC.
It is very likely that all VAT registered businesses will be required to keep VAT records digitally and file VAT returns using commercial software in the not too distant future once the Making Tax Digital initiative is rolled out to voluntarily VAT registered businesses. At the moment these requirements just apply to businesses who are compulsorily registered for VAT.
If you change roles and are no longer self-employed then it is your responsibility to de-register so you are no longer expected to complete and file VAT returns.
There are very strict penalties for non-compliance with the VAT return requirements and deadlines and it is certainly not something to be taken on lightly or entered into with a short term or casual attitude.
Taking all of this together, if you want to register for VAT, we would strongly recommend that you seek professional advice and assistance, due to the additional administrative obligations it would place on you. We have some guidance on finding a professional adviser.
THE BOTTOM LINE: not only are the ‘benefits’ of being VAT registered/in the FRS often not as large as perceived, but they can be easily eroded by penalties for getting things wrong or in the alternative, ongoing accountancy fees.
A final twist
Often in low paid work, it is not always clear whether a worker is genuinely self-employed, or whether actually, they should be treated like an employee by their engager.
Self-employment is a question of fact, not choice – we have guidance on some of the factors to consider.
The problem here is that if HMRC consider you to be an employee for tax purposes, a VAT registration wouldn’t be appropriate (and they would expect the company you work for to operate Pay As You Earn tax and National Insurance on your wages, at the very least!).
It is possible that HMRC will undertake VAT pre-registration enquiries as to your situation, and if they decide that your situation doesn’t look like genuine self-employment, this may lead to them rejecting the VAT registration application and/or possibly commencing other enquiries.
There is therefore a lot to consider. Please do your research before being too swayed by the thought of being able to invoice more if you are VAT registered! It may not be all it is cracked up to be and could land you with serious problems with HMRC that you really don’t want or need.