Value Added Tax, or VAT, is a sales tax collected and administered in the United Kingdom, or UK, by the department of Her Majesty's Revenue and Customs, or HMRC. Most goods and services attract VAT at the standard rate of 17.5 per cent, but a special rate of 5 per cent is added to goods such as domestic fuel, while food and books are zero-rated, meaning that no VAT is added to their sales price. Businesses with an annual turnover of more than £70,000 have to register for VAT, but voluntary registration brings advantages to some businesses with a turnover lower than £70,000.
VAT registration makes a business seem established and permanent. It also shows that the proprietors of the business are serious about running the business, because they are willing to undergo the extra work involved in record keeping and filing returns, which become legal obligations when a business is registered for VAT. When a small business does not have a VAT registration number, sometimes other businesses are reluctant to do business on favourable terms. They may feel that a business without VAT registration could fail, on account of being either new to the market or so small that it could encounter cash-flow problems that hamper its ability to deliver what it contracts to deliver. In these circumstances, the unregistered business may not receive credit terms, so that it always has to find money to pay for any supplies upon or before delivery. Anyone buying goods from an unregistered business may also be concerned about paying for goods and services supplied by the business, prior to delivery. VAT registration makes a business look more credible to both customers and suppliers.
Once a business registers for VAT, it can claim back the VAT component of any goods or services it pays for in the running of the business. For example, a small business that sells mainly to other VAT-registered businesses has to pay the VAT component of any goods that it purchases wholesale, to sell on to its customers. If the small business is not registered for VAT, it cannot claim back the VAT on the goods that it has purchased. If the small business needs to make a 10 per cent profit on all the goods it sells, it has to add 10 per cent to the purchase price of those goods, including the VAT component. If it is VAT-registered, and can claim back the VAT component of its purchases, it needs to add only 10 per cent to the cost of the goods excluding the VAT component, meaning that it can maintain its desired profit margin while charging a lower price to its customers. This means that it can charge a more competitive price for its products.
Even if a business sells only zero-rated goods, such as food, books and magazines, it can still claim back the VAT component of any goods and services it purchases in the running of the business. This means that following every VAT return, it will receive a rebate from the HMRC for the value of VAT it has paid out. This is virtually cost-free revenue for the business, since the only cost involved is that of preparing and filing the VAT return.