Alright, 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