How VAT works, and when you must register

VAT is a tax on consumption, collected by businesses on behalf of HMRC. A registered business charges VAT on what it sells, which is output tax, and reclaims VAT on what it buys for business purposes, which is input tax. It pays HMRC the difference. If input tax exceeds output tax, HMRC repays the difference. The business is a collector, not the taxpayer, and that is why VAT money should never be treated as working capital that belongs to the business.

Because it is HMRC's money, the penalties for getting it wrong are real. That is also why VAT sits in a unit alongside ethics: the person doing the return has a professional duty to get it right and to speak up if asked to do otherwise.

The historic test and the future test

The historic test looks back over the last twelve months, month by month, at the end of every month. Once the cumulative figure passes the threshold, the business has thirty days to notify HMRC and is registered from the first day of the second month after the breach. The future test looks forward: if the business knows that taxable turnover in the next thirty days alone will exceed the threshold, perhaps because it has won one very large contract, it must notify within those thirty days and is registered immediately.

Only taxable turnover counts, which means standard, reduced and zero rated supplies. Exempt supplies and supplies outside the scope are excluded, as are sales of capital assets. Learners routinely add exempt income into the test and reach the wrong conclusion, so read the breakdown carefully before you total anything.

Why a small business might register voluntarily

• It can reclaim input tax on purchases and expenses
• It looks larger and more established to business customers
• Zero rated sellers can reclaim input tax while charging no output tax, producing regular repayments
• It avoids the administrative shock of a rushed compulsory registration later