When to account for income and expenses: part 2
We’ve previously looked at when income and expenses go into your profit and loss account.
In this article, we’ll see when they’ll appear on your VAT returns. There are some questions you can ask yourself to make sure you’ve put your income and expenses into the right VAT return.
The basic rules to look at are:
- Are you using the cash accounting scheme?
- Are you on the Flat Rate Scheme?
But this is VAT so there are bound to be additional points to look at. For example:
If a cost is paid for by credit card and there’s no bill, does that cost appear on your VAT return
- on the day the credit card is presented to the supplier, or
- when the business pays off the credit card balance from its bank account?
And does it matter in that situation whether or not your business is using the cash accounting scheme?
If a cost is paid for personally and then the business pays the individual back, does that cost appear on your VAT return
- when the individual incurs the cost, or
- when the business pays the individual back?
And again, does it matter in that situation whether or not your business is using the cash accounting scheme?
Let’s look more closely.
1) Cash accounting scheme
A lot of small businesses use the cash accounting scheme for VAT.
This means that invoices and bills will only appear on their VAT returns when their customer pays them for the invoice, or when they pay their supplier for the bill.
This is as opposed to the standard way of accounting for VAT (sometimes called “invoice accounting”), which we’ll look at shortly.
You don’t have to apply to HMRC to start using the cash accounting scheme, but not all businesses may use it.
For example, if your business’s sales are over the limit to start using the cash accounting scheme (currently that’s £1.35 million a year), or if you’re behind with your VAT returns or payments, or have recently been convicted of a VAT offence, you can’t use cash accounting.
You’ll have to use…
2) Invoice accounting
Businesses who are invoice accounting for VAT must include the VAT that they charge to customers on their invoices on the VAT return that covers the quarter in which the invoice is dated – whether or not their customer has paid them yet.
Bills work the same way. So a business that’s invoice accounting for VAT can claim any VAT back on a bill, in the VAT return that covers the quarter in which the bill is dated – regardless of whether they’ve actually paid that supplier yet.
This method works very well for retail businesses, whose customers would almost always pay straight away. It doesn’t work quite so well for businesses who offer credit and have late- or non-paying customers.
3) Flat rate scheme
Very small businesses may use the VAT Flat Rate Scheme, in which, instead of paying to HMRC the amount of VAT you collect from your customers less the amount you pay your suppliers, you take a percentage of your VAT-inclusive sales and pay that to HMRC.
The percentages are set by HMRC and vary depending on your business’s trade.
Being on the Flat Rate Scheme can save you some money but that’s not what it’s intended for. HMRC created it to make record-keeping simpler for small businesses.
There are some aspects of the VAT Flat Rate Scheme that can cause confusion:
- You do have to apply to HMRC to join the scheme and that’s a different process from applying to register for VAT.
- In your first year of being registered for VAT (NOT of being on the Flat Rate Scheme!) you take 1% off your flat rate percentage as a discount.
- Costs won’t appear on your VAT return when you’re on the Flat Rate Scheme, unless they’re for the purchase of a capital asset which cost over £2,000.
- Interest on a business bank account used to form part of your Flat Rate Scheme but, in a change to HMRC’s policy, now does so no longer! We’ll publish more guidance shortly on how FreeAgent will handle this.
- When you’re setting up your FreeAgent account, on the VAT screen make sure you leave the “Flat Rate Scheme” box as “Not On Flat Rate Scheme” unless you’ve applied to join the Flat Rate Scheme and been accepted by HMRC.
The Flat Rate Scheme has its own “cash-based method” which works just like the cash accounting scheme. So if you’re on the Flat Rate Scheme and using the cash-based method, you’d work out your VAT-inclusive turnover for that quarter by adding up all the money you’ve received from your customers. If you’re on the Flat Rate Scheme and not using the cash-based method, you’d add up the amounts you’ve invoiced your customers for during the quarter.
Remember in both cases to also include certain other income which you might not normally think of putting on your VAT return; for example, sales that are exempt from VAT, and sales to other EU countries.
But income that’s outside the scope of VAT, such as sales outside the EU, doesn’t form part of your Flat Rate Scheme turnover.
Now let’s have a look at some of the more quirky VAT situations.
4) Credit card payment with no bill
If you explain a transaction with type Payment (not Bill Payment) on FreeAgent, it’ll go into your VAT return for the quarter in which the payment is dated, whether or not you’re using the cash accounting scheme.
But what if you’re using a credit card? Is the payment date the date when you hand your credit card to the supplier, or when you pay off your credit card bill?
The answer is the first one.
So if you go to Staples on 10th March 2011 and buy a pack of box files, and you pay your credit card off with a bank transfer on 30th April 2011, the purchase of the box files goes onto your VAT return to 31st March 2011 – not 30th June 2011 – whether you’re using the cash accounting scheme for VAT or not.
If you’re on the Flat Rate Scheme then this payment wouldn’t appear on your VAT return anyway.
5) Cost incurred personally
Again the cost goes on to your VAT return when the individual incurs the cost, not when the business pays him/her back – and again this applies whether or not you’re using the cash accounting scheme.
And now for the good news!
FreeAgent will handle everything covered in this article for you automatically, so long as it’s set up correctly!
When you set up your VAT in FreeAgent, do make sure you choose the correct basis (invoice or cash) and the correct setting for the Flat Rate Scheme. Remember, if you’re not registered with HMRC to use the Flat Rate Scheme, then you need to choose “Not on Flat Rate Scheme”.
This post should though help you understand what FreeAgent is doing when it calculates your VAT.
Disclaimer: The content included in this blog post is based on our understanding of tax law at the time of publication. It may be subject to change and may not be applicable to your circumstances, so should not be relied upon. You are responsible for complying with tax law and should seek independent advice if you require further information about the content included in this blog post. If you don't have an accountant, take a look at our directory to find a FreeAgent Practice Partner based in your local area.