Complete Guide To VAT For Freelancers And Contractors

A zero-jargon guide to VAT

Written by 
Updated on
May 28, 2024

Introduction

VAT, or Value Added Tax, is a tax you pay when you buy a product or service. But how does it affect freelancers like you?

In this article we break down what VAT is, how it works, considerations of whether you should be VAT registered and outline the requirements of VAT registered companies.  

What is VAT?

Value Added Tax or VAT is a tax charged on most goods and services sold by VAT-registered businesses in the UK. 

If a business is registered for VAT, it has to charge VAT on all its taxable sales. In most cases, the business is also entitled to claim back the VAT that it’s charged by its suppliers.

Because VAT registered businesses can reclaim VAT they’ve been charged, it is not a tax on most businesses. The cost of VAT is ultimately borne by either a consumer or business that is not VAT registered and therefore not entitled to reclaim the VAT it has paid. 

What is a VAT return?

Every quarter VAT registered business must submit a VAT return detailing all the sales and purchases they have made, how much VAT was due on each transaction, and how much VAT is due overall. 

Since 1st April 2022 all VAT-registered businesses are now required to submit VAT returns electronically through an initiative called Making Tax Digital (MTD)

VAT returns may sound daunting, but they’re extremely easy and fully automated with smart tax tools like Mighty that will handle everything for you. 

When must you become VAT registered?

You must legally become VAT registered if you expect your revenue in any rolling 12-month period to exceed £90,000.

Are there any exceptions to when you must register for VAT?

If you believe your turnover will decrease below the threshold in the near future, you can apply for a VAT exemption. For example, if you’ve seen a recent boom that has affected your income, but is not expected to last. 

In order to get your exemption, you will need to write to the HMRC and send them the evidence of your turnover and how it’s projected to drop below the threshold.

Mighty will help all customers do this, it is a very quick and easy process. HMRC will then review your case and issue and confirm an exception in writing, or register you for VAT. 

Should you volunteer for VAT registration?

Even if you don't hit the threshold, registering voluntarily can be highly beneficial as it can let you reclaim VAT paid on purchases and enhance your business profile. 

The pros and cons of VAT registration

Pros:

Being VAT registered means you can claim back the VAT that you’ve paid on goods and services bought. This can potentially save you a vast amount of tax. 

  • For example: If you buy a new laptop for £2,400 pounds including VAT, being VAT registered means you can reclaim £400 of VAT on this. In other words the laptop only costs you £2000 excluding VAT.
  • That’s a big tax saving you can immediately make by being VAT registered. 

Being VAT registered can enhance your company profile.

  • Due to the £85,000 VAT threshold it is relatively common for potential customers to view VAT registered businesses as more successful. 
  • Giving the impression of having a turnover can be reassuring to prospective customers who may be nervous about working with smaller businesses. 

Cons:

One of the obligations of being VAT registered is to submit a VAT return each quarter.

  • If you’re doing this manually it can be confusing and very time consuming and if you file VAT return late, you may receive a fine from HMRC. 
  • However accounting software like Mighty will manage all your VAT calculations and submissions for you. All your VAT is calculated and submitted to HMRC in a click, so VAT submissions should never be a problem 

Increased Prices: 

  • If your customers are consumers or small businesses that are not VAT registered, your services might become less competitive. This is because they cannot claim back the 20% VAT you will add to their invoice. 
  • However if your customers are VAT registered businesses, they will be able to reclaim the VAT you have charged them. In other words, there is no increase in price to them and therefore no negative effect to your business. 

Therefore if you sell to other businesses and use software to handle your VAT there is no real downside to being VAT registered as it means you can save tax that you would otherwise pay.

What VAT schemes are there? Standard vs Flat Rate

So you want (or need) to register for VAT? The next step is choosing which VAT scheme is right for you. 

There are two primary schemes are the Standard Rate and the Flat Rate Scheme. 

Standard scheme: 

  • Under the standard VAT scheme you pay HMRC the difference between the VAT you charge customers and what you pay suppliers.
  • You charge your clients the standard rate of VAT on their invoices (20%) and can reclaim VAT on all business purchases and expenses that you’ve paid VAT on. 
  • So if you charged customers £2000 of VAT on your invoices, and paid £500 of VAT on your expenses, you would pay HMRC the difference of £1500. 

Flat Rate Scheme (FRS): 

  • Under the flat rate scheme, things are slightly different. 
  • You still charge your clients the standard rate of VAT on their invoices (20%), but you pay HMRC a lower percentage than 20% - and keep the difference.
  • The exact percentage you pay HMRC depends on the type of business you operate. For example; if you run an advertising business you only pay HMRC 11%. 
  • That means you keep the 9% difference between the 20% you charged clients and the 11% you pay to HMRC. In effect it’s extra money in your pocket. 
  • You can find what % your business would pay on HMRC’s website here.
  • The downside of the flat rate scheme is that you can't reclaim the VAT on purchases or expenses unless they are fixed asset purchases (e.g. computers and cameras) worth over £2000. 
  • It’s also worth noting that the Flat Rate Scheme is only open to business with a turnover of under £150,000 in any 12 month rolling period. 

So which scheme is right for you? 

  • The choice between Flat Rate and Standard VAT schemes largely depends on the nature and operations of your business.
  • If you have very few VATable costs, the Flat Rate scheme may be best for you. You effectively make more money, can still reclaim VAT on large purchases, but can’t reclaim VAT on smaller day-to-day transactions.
  • However, if you regularly buy fairly expensive items or services that you’re charged VAT on, the Standard VAT scheme might be more suitable as you get to reclaim VAT on all those purchases. 


Our advice would be to always consult with your accountant. If you’re a Mighty customer, we provide this consultation 100% free of charge. 

FAQs on VAT

Can you claim back VAT from before you were a limited company?

  • Generally, you can reclaim VAT on goods bought up to four years before registration and services bought up to six months before registration, provided they’re for your current business.
  • This can equate to huge savings - especially if you’ve bought expensive laptops, cameras and software that had VAT charged on them 
  • Mighty makes reclaiming VAT on these expenses incredibly easy to do. 
  • Simply add an expense, detail the VAT you were charged and attach the original invoice / receipt. Mighty will then automatically reclaim the VAT for you on your next VAT return.  

What are your obligations if you're VAT registered?

  • You must charge VAT on your invoices and clearly outline any VAT amount charged, with your VAT number included on the invoice. 
  • You must also submit quarterly VAT returns, and keep detailed records of all your transactions. 
  • This may sound onerous but a system like Mighty will take care of everything for you. 
  • Mighty will automate your bookkeeping to reclaim VAT for you, add VAT to your invoices and complete your quarterly submissions for you.
  • Mighty’s platform will even tell you how much VAT you’ve collected, reclaimed and owe to HMRC in real time (so there are no nasty surprises). 

How do you register for VAT?

  • You can register VAT yourself through the HMRC website
  • Alternatively, let our expert team at Mighty help you through each step, ensuring a smooth registration.

Do I need an accountant to register for VAT?

  • While not mandatory, an accountant or a platform like Mighty can make the process seamless.

How do I charge VAT?

  • Add the applicable VAT rate to your invoice - usually the standard rate of 20%. 
  • If you’re VAT registered and a Mighty customer, Mighty will automatically do this for you. 

How do I claim back VAT?

  • Record and submit your VATable expenses detailing how much VAT you were charged. 
  • Remember, platforms like Mighty can automate this.

What does VAT exempt mean? 

  • Some sales of goods and services are exempt from VAT. That means if you sell these goods and services you won’t charge your customers any VAT, and if you buy them there will be no VAT to reclaim.
  • Examples of these goods and services include postage stamps, insurance, and certain medical services.

What does zero VAT rated mean?

  • Zero VAT rated items are items that the government technically charges VAT on but currently have the rate set to zero. For example; water, basic food, train tickets, books and newspapers.

In Conclusion

Understanding VAT might initially seem complex, but with clear guidance and the right tools, it's straightforward and shouldn’t cause you any headaches. 

Mighty is here to save you time, money and stress across your entire accounting process. Our friendly expert team is always on hand to help. Discover more at Mighty accounting.

Content:
All your accounting sorted for just £49 pm
Try Mighty free
No credit card required

Accounting for the small & mighty

All your accounting, only £49+VAT per month

Try Mighty free
No credit card required

View similar posts

Or view all our resources