A lright, so this isn’t the most thrilling post-title ever. Hell, if you clicked through from Twitter then you must be either very loyal, or very bored. Accounting isn’t fun and it isn’t particularly interesting but it’s important. For legal reasons I should mention that I’m not an accountant; anything written here is based solely on my own experiences and is not intended as financial advice.
What I’ll discuss here is only really relevant to anyone who is set up as a limited company in the United Kingdom.
VAT, The Flat Rate Scheme and What Accountants Tell you
In the UK, all businesses must register for VAT (Value Added Tax) if they turn over more than £68,000 per annum. If you are registered for VAT then you have to charge VAT to all your clients, so add 17.5% on to whatever your prices are. A minor plus-point is that you can also claim back VAT on any expenses – so that new iPad will only cost you £360 instead of £430.
When you first incorporate a limited company in the web design sector, most accountants will strongly advise you to voluntarily register for VAT under the “Flat Rate Scheme” which means you charge your customers 17.5% VAT, but you only have to pay HMRC (Her Majesty’s Revenue & Customs) 10% – meaning you keep a 7.5% profit on every sale. Sounds great, right? Free money – wohoo!
Forget about it.
Why That Makes Absolutely No Sense
To sum it up as succinctly as possible: VAT sucks. It is the biggest, most royal pain in the arse that you could possibly come across as a newly established business. You have to file VAT returns four times a year and you can never easily know how much of the money in your bank account is yours and how much should be held back to pay your next VAT return.
Oh, and the Flat Rate scheme doesn’t allow you to claim back money for expenses either, sorry.
Here’s the real kicker though: Speaking from experience, all of my clients have a fixed budget (even the really big ones). They don’t have a budget +VAT, they don’t have a budget which can be stretched by around 20%. They have a fixed budget.
Rather than try to laboriously explain this – let’s take a look at a simple example.
- Client1 wants a website and has £5,000 to spend.
- WebDesigner1 is registered for VAT under the Flat Rate scheme, which his accountants have told him is brilliant.
- WebDesisnger2 knows better and is not registered for VAT at all.
Both web designers make less than £68,000 a year, so VAT registration is completely optional.
- WebDesigner1 invoices the client £4,250+VAT (£4,993.75) – he pays 10% VAT to HMRC (£425) which involves several hours of admin and additional accounting costs, he finally keeps £4,568.75.
- WebDesigner2 invoices the client £4,993.75 – he keeps £4,993.75.
See what happened there? If your client has a fixed budget then you’re actually losing 10% on every project, not making 7.5%.
In Conclusion
My original accountants talked me into registering for the VAT Flat Rate scheme a year ago and it has caused me nothing but problems and headaches. I’ve just managed to de-register after an extremely long and painful process involving a lot of paperwork.
Once again, I’m not a financial advisor, but for anyone who is in the service industry doing business with clients who have a fixed budget – I would NOT recommend subjecting yourself to the VAT Flat Rate scheme.
Photo by alancleaver
Great post. I did wonder if the negatives outweighed the positives for being VAT registerd whilst under the threshold. I will definatly take your advice!
I do get your point on VAT but dont necessarily agree that it is as bad as you make it out.
Some of the points you mentioned:
“You have to file VAT returns four times a year” – Most good account software will give you a break down of the VAT you owe and if you register for submissions online then you have to complete about 6 boxes (which you just copy from your accounts software) and click next a few times. A very simple process
“you can never easily know how much of the money in your bank account is yours” – Why not just open a second account and with every invoice paid just transfer the VAT into that account.
With regards to fixed budgets, a big point you are missing out on is if the client is VAT registered. Most of my clients are VAT registered and in my experience most clients with £5k budgets would be in the same position.
Just as you said that buying an iPad will cost you £360 instead of £430, for the client they are buying a website for £5000 instead of £5875 (£5k + VAT).
I am no financial expert and I have had this internal VAT battle with myself for some time. But if managed correctly being VAT registered can save your business money.
“Most good account software will give you a break down of the VAT you owe” – Yes, but then – if you’re sensible – you pay an accountant to verify it, which is more time, money, and headaches.
“Why not just open a second account” – I’m sorry but that’s just madness, I have enough bank accounts as it it!
“they are buying a website for £5000 instead of £5875 (£5k + VAT)” – I take your point, but they don’t see it that way, and more importantly, not all of them are VAT registered!
“But if managed correctly being VAT registered can save your business money.” – You haven’t said anything at all to back up that statement!
“Yes, but then – if you’re sensible – you pay an accountant to verify it, which is more time, money, and headaches.” – Depends on how complicated your accounts are but you would not need to get an accountant to verify every quarter. Maybe get them to check once a year or every other submission to sanity check.
“I’m sorry but that’s just madness, I have enough bank accounts as it it!” – But it does make handling money easier. Transfer all you VAT and Income Tax each month and then you wont get a large chunk taken from your operating funds each qaurter / year. My “bills” account is purely an online one so once setup I dont even think about it.
“not all of them are VAT registered!” – Then that is a decision each business needs to make, if you find the majority of your clients are not VAT registered then it may be a better option to not be yourself. It will help you be more competative.
“You haven’t said anything at all to back up that statement!” – Was trying to keep the post short :) – For me I pay VAT on all my outgoings, I get to claim VAT back, which can be hundreds per month. I would not notice that benefit if I did not handle my VAT correctly and it would just seem like another bill.
I dont believe VAT is perfect for every business, it depends on your clients, the effort you can put into managing it, your outgoings and most importantly (which goes back to your original point), you should never drop your rate to accommodate VAT. For me I quote then add VAT at the end.
I am in no way an expert on this and just know what works for me and my business.
Good points all round, thanks for taking the time to type them out! :)
Only one thing from me – you mentioned saving money by claiming money back, I agree with this completely – but only if you’re NOT on the Flat Rate Scheme, which doesn’t allow you to claim anything back at all :(
Thanks for a nice and informative outline of VAT. It makes a lot of sense when someone takes the time to explain it in a simply way, and point out the pitfalls.
If your dealing with a big client then they will probably be VAT registered as well which means they don’t have to pay VAT or they can claim it back again. In this situation you back to making 7.5%.
It is a big hassle dealing with VAT but if your clientèle are mainly large companies or people who are VAT registered it does have its benefits.
I’ve yet to come across a VAT registered client who handles it in that way – and it’s really not worth the unbelievable headaches that it causes. The billable hours that I’ve spent trying to wade through VAT crap are worth a LOT more than 7.5% of what I’ve invoiced.
One important point you have not mentioned is that if you purchase an item of capital equipment for more than £2000 you CAN claim the VAT back even under the flat rate scheme.
http://www.hmrc.gov.uk/vat/start/schemes/flat-rate.htm#8
Hi Andrew – I’m aware of that fact but in my opinion it’s not at all relevant to this industry. Name me one thing that web designer will buy that costs more than £2,000 ? Even the most expensive Macs are less than that. It provides no benefit at all to most people.
John,
A good post all round and I can only encourage people starting out to NOT register for VAT. That’s what I did and it really does help when starting up.
The reason I say that is because when you’re established, you WILL be travelling a lot, you will be buying the new laptops, the new software, the new furnature, and can claim back all of the VAT on that so it makes perfect business sense.
However when starting out, you are trying to make use of what you have, as outgoings kill a new business. You don’t wan’t to buy a new laptop until you can very comfortably afford it, you don’t need a new desk and chair – make use of the ones you have for now.
You also need to stay competative – as you have correctly pointed out John, you need to charge VAT on all of your jobs. When you start out, chances are you aren’t going to get the clients who pay £5000 per job, they will be more like £1000 per job (maximum when starting!) – these businesses probably wont be VAT registered either, so can’t claim back VAT so have to take the extra 17.5% hit – cost is an extremely important factor for these guys.
So if they have an offer for a website design costing either £1000 or £1175, who do you think they will go for?
I would also caution people reading your 2 website designer examples at the bottom of your post in too much detail. If you aren’t registered for VAT, I wouldn’t reccomend you charge what you would if you were VAT registered as you wont be competative.
Companies who can claim back VAT won’t be able to, so it makes sense for them to go for a VAT registered company and in your example above, they would be able to claim back £743.75 at the end of the year on that job, and you would still get the 7.5%. As for the smaller guys will just get stung by you, and you probably wont get a great deal of work by quoting prices as if you were VAT registered. When starting out, I found not being VAT registered was a huge advantage and selling point to the small guys.
I hope that makes sense, and is just my opinion. It’s a great post and everyone starting out should listen up.
I think a follow up post on this emphasising the importance as registering as a Limited Company as opposed to going at it as a Sole Trader would be very valuable to people reading this. I remember that was a very tough decision for me, but in the end being a Limited Company has proved to have no end of benefits. Feel free to contact me if you want my personal views on this, I’d be happy to share them…
Really good post.
I’ve yet to meet an accountant that wouldn’t “push” you to register for VAT. It makes perfect “business sense”… for them. :)
I’m an accountant AND a web designer.. bet there’s not many of those around ;-). To reply to the last post, as an accountant we only recommend our contractor clients to register for VAT when it benefits them. For example, when they are working for VAT registered companies all the time, they can simply add 17.5% to their sales without it costing their “employer” any more, but they only pay 11% of that VAT over. They really do profit on the scheme – some of our clients profit by as much as £5k-£6k per year on the scheme, which pays for our accounting fees 8-10 times over. The only way IT contractors, web designers etc don’t benefit on the flat rate scheme is when you work more for non-VAT registered clients, in which case you have to add 10-13% (depending on your flat rate) to your quote compared to what you could offer if you were not VAT registered. But work for a non-VAt registered client is likely to be smaller and lower value, so even taking the hit of 10-13% yourself (effectively paying the VAT for the customer) you would still probably benefit over the year.
IF you are VAT registered, the flat rate scheme is definitely better for most web developers, who have little in the way of VATable expenses to claim back compared to their sales. In addition, the clients that are VAT registered themselves will not be worried about the VAT. You say in the article that they don’t see it like that, but I would say you are incorrect. I have worked with many company directors and businesses, and most either a) see being able to claim the VAT back as a good thing – they can deduct that £875 from what they have to pay to HMRC, which is a great psychological bonus, or b) don’t factor in the VAT they have to pay at all (i.e. to them it’s costing them £5000, not £5875).
There’s also the fact that some businesses simply wouldn’t go to a web designer that was not VAT registered. Not being VAT registered would, to some, mean you are a small company and therefore not able to cater to the needs of a larger company. Of course this isn’t necessarily true at all, but it’s all about other people’s perceptions.
I’m not saying every web designer should register for VAT, but if you find yourself working for VAT registered companies most of the time you should definitely consider it – there really is profit to be made from the flat rate scheme which will probably pay for your ENTIRE accountancy fees, let alone the additional fees for accounting for VAT (which , by the way, you don’t really need – many of our clients do their own VAT which only gets checked/any mistakes corrected at the year end).
–”the clients that are VAT registered themselves will not be worried about the VAT. You say in the article that they don’t see it like that, but I would say you are incorrect.”
It is impossible for me to be incorrect on that particular point, as I was stating a fact, not an opinion.
–”I have worked with many company directors and businesses, and most either a) see being able to claim the VAT back as a good thing”
What’s a good thing? Paying something and claiming it back? or not paying it at all? I know which I’d choose.
–”There’s also the fact that some businesses simply wouldn’t go to a web designer that was not VAT registered.”
I’m sorry, but that’s just flat-out not true, and if a company didn’t want to work with me based on my VAT registration status, then I would refuse to work with them out of principle. That’s not the sort of client I want.
As for the rest of what you said, I completely disagree for all the reasons which I stated in the original article.
As a further note to what Andy said, registering as a limited company (approx £80 to register a company and shouldnt cost you any more in accountancy fees than being a sole trader) is definitely worthwhile – it gives you much more scope for managing personal tax and how you withdraw money from the business (and helps in keeping out of the dreaded 40% tax bracket!)
I do trade as a limited company and I assure you that it cost me £25 not £80.
Hm – interesting.
We’ve been umming and ahing (is that correct?!) over whether to go VAT registratered, and if so which type for a while now.
Our accountant sat down with us, looked at our turnover, VATable expenses and figured out how much we’d “make” on flat rate or save on normal VAT regsitration, and it was very little, so when compared to the potential lost business by charging other non-regsitered clients an extra 17.5% on all invoices, we decided to stay non-registered.
Then I was talking to someone who runs a reasonable sized IT firm the other day who paid a significant amount for their website, and he said the fact we weren’t VAT registered would put him off using us. He argued that to a lot of medium / large companies / agencies that are VAT registered, would percieve a web agency that wasn’t to be small / inexperienced / not professional.
He wasnt being nasty, or derisive about it, just stating his perception.
I know you said you disagree with that, and in many ways I do too – I think its an elitist approach to take that can mean you pass over some very good providers, but you can’t argue that there are some people out there that do, rightly or wrongly, percieve things that way.
And then there will be smaller non-registred companies that will, like others have said, find working with another non-registered business beneficial as we can essentially come in cheaper than a VAT registered company for the same product, and is something we’ve found has won us projects too.
In other words, it all comes down to what your typical / ideal client is.
I completely agree Andy, thanks so much for taking the time to leave such a detailed comment! :)
No probs.
Thanks for the info on VAT….
I’ve got 4 businesses, personal training under 60k p/a so im not subjecting that the VAT, when i have…
another business which works with subcontracting pt’s (as an agent) which turns over £68k and claims back all expenses and is better off on VAT due to all marketing and general expenses which incure VAT.
my other businesses have to claim back VAT as they’re too higher turnover and have no option….
but i would agree if you are a 1 man band and your turn over is less than 68k, avoid it! i do and on my own PT i save 7.5% at least p/a through the flat rate scheme…
G