The basics of VAT in the trade industry

There are a host of challenges that electrical contractors face in running their companies. Benjamin Dyer of Powered Now looks at one of them – dealing with VAT.

The definition of VAT

VAT is “Value Added Tax”. This is a tax which every business with sales over £85,000 must add to their sales invoices.

For example, an electrician does a job where they buy £1,000 of materials with £200 VAT at 20%, giving a total materials bill to be paid of £1,200. They do £5,000 worth of labour so they charge £1,000 + £5,000 = £6,000 then add £1,200 VAT at 20%, giving a total bill to the customer of £7,200.

It seems like the installer is £200 (the VAT on the materials) out of pocket but this isn’t the case. The installer only has to pay HMRC £1,200 (the VAT received from the customer) - £200 (the amount paid to the supplier) = £1,000. So, out of the £7,200 received, they pay £1,200 to the supplier, £1,000 to HMRC and get the full £5,000 for their labour.

Using the same example, a non-VAT registered business would charge the customer £1,200 (the amount they paid for materials including VAT) + £5,000 (the amount for their labour) = £6,200. This is £1,000 less than the VAT registered installer for the same work and pay.

This gives the non-VAT registered business a competitive advantage.

Read more: Pros and cons of voluntary VAT registration

Different VAT rates

The following are the VAT rates used in the UK:

  • Standard Rate (20%)
  • Exempt - no VAT
  • Zero (0%)
  • Reduced rate (5%)

Examples of things that are exempt from VAT are postage stamps, insurance and education.

Mostly, the standard rate of 20% is used. New builds are usually zero rated and some conversions and refurbishments qualify for the reduced rate of 5%. Other work qualifying for this lower rate are the installation of energy saving devices and installations relating to people’s disabilities.

Minimising VAT

It might seem obvious to try to minimise VAT by setting up many companies each of which would be under the VAT limit. However, this isn’t allowed. Setting up “Electricians North East London”, “Electricians North London” etc. to avoid VAT is disallowed, whether these are separate companies or just trading names.

If you are getting close to the VAT threshold, one way to keep that at bay is to get customers to pay directly for the materials. If you buy a distribution board and the cost is passed on to the end customer, it forms part of your sales whether a mark-up is added or not. There is a way to buy materials and not include them on your VAT return – disbursements – but this is quite complicated.

Read more: When does MTD start?

Choosing the VAT scheme

The normal VAT scheme is where a business submits their VAT return once every three months based on sales and costs invoiced in that three-month period. These are included based on the date they were raised whether or not they have been paid.

The alternatives are the “Cash accounting” and “Flat rate” schemes. Unfortunately there isn’t room to cover these here. The Cash accounting scheme means you base your VAT return on what payments you have received and made in the quarter. Advice should be taken from an accountant as to which scheme is best for you.

Read more: Why is MTD being introduced?

Professional advice

VAT is complicated, particularly for the trade industry. I am not an accountant although I have checked the advice here with an accountant. Really, consulting an accountant usually saves much more than it costs. It’s definitely worth doing this at least once for VAT to set you off on the right track.

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