UK VAT accounting schemes
Following on from a Twitter conversation between @anujgakhar and @newtriks, here’s some help with the different ways you can account for VAT.
If you’re registered for VAT, you’ll either be “invoice accounting for VAT” or “cash accounting for VAT”.
What do those terms mean?
Invoice accounting – sometimes called standard accounting – means that you have to pay VAT to HMRC as you raise invoices.
Cash accounting means that you only have to pay VAT to HMRC when your customers pay you.
Let’s take an example.
Mary is a freelance web designer. On 1st February 2011 she issued an invoice to her customer Jack, for £1,000 + VAT, so £1,200 in full.
She will have to pay £200 to HMRC.
Mary prepares her VAT returns to 31st March, 30th June, 30th September and 31st December each year.
Jack pays Mary’s invoice on 1st April 2011 – so the invoice falls into the quarter ended 31st March, while the payment falls into the quarter ended 30th June.
If Mary is invoice accounting for VAT, she must include the £200 from this invoice on her March VAT return and pay it over to HMRC by 30th April (7th May if she is paying online).
But if she is cash accounting for VAT, she won’t have to include the £200 from this invoice until her June VAT return, because that was the period in which Jack paid her - so she won’t have to pay it to HMRC until 31st July, or 7th August if she’s paying online.
So cash accounting can be better for your cash flow, because you won’t have to pay HMRC their VAT until your customers have paid you for their invoices. You don’t have to find the money from somewhere else.
Does it work the same way for bills from my suppliers?
If you’re invoice accounting, you can reclaim any input VAT on the return during which your supplier invoices you.
If you’re cash accounting, you can’t reclaim any input VAT until you actually pay your supplier.
So if you tend to pay your bills promptly, it won’t make a big difference from that point of view whether you’re invoice or cash accounting.
But if your customers always pay you immediately (for example, your business is a retail shop), then you may be well advised to stick to invoice accounting, so that you can reclaim the VAT promptly on your bills from your suppliers.
What about when customers don’t pay me?
If you have a bad debt, i.e. your customer doesn’t pay you for a particular invoice, then this will be handled differently depending on which method you’re using to account for your VAT.
If you’re cash accounting, you wouldn’t have paid the VAT on that invoice over to HMRC anyway, so there’s no harm done.
But if you’re invoice accounting, then you’d be out of pocket, because you’ll have already paid the VAT to HMRC, but you’re not going to be paid it back by your customer.
You can reclaim that VAT back from HMRC, which is called “bad debt relief”.
There are, unsurprisingly, strings attached here.
You can, for example, only claim back bad debt relief on debts that are more than 6 months old – even if you know for certain before that time that your customer won’t pay you, say if they’ve gone into liquidation. (That did happen to a client of mine.)
HMRC have more information.
Be careful too. You must only reclaim the VAT you paid over to HMRC in the first place – so as the VAT rate has just changed, that could well be 17.5% rather than 20%.
What if a customer pays me in advance of an invoice?
Even if you’re invoice accounting for VAT, you would be liable to pay the VAT at the point the customer paid you, if the customer pays in advance.
This is because a payment from a customer creates a “tax point”, at which point VAT becomes payable.
What if I’m also on the flat rate scheme?
This has its own “cash-based method” that you can use. In short, instead of adding up all your sales invoices, you'd add up all the money your customers paid you for that quarter.
Can anyone use the cash accounting scheme?
It’s aimed at smaller businesses – so your estimated VAT taxable sales for the next 12 months must be no more than £1.35 million.
Once you’ve joined the scheme, you can stay on it until your annual VAT taxable sales level breaks £1.6 million.
You can’t use cash accounting if you’re behind with your VAT returns or payments, or have been convicted of a VAT offence or charged a penalty for VAT evasion in the last year.
Do I have to tell HMRC when I start or stop using the cash accounting scheme?
No, you don’t.
It could be beneficial to your business to use the cash accounting scheme, but equally it's not available for everyone. If in doubt, do seek your accountant's advice.