Value Added Tax, or VAT, is a tax applied to the sale of goods and services in the United Kingdom (UK). Applying VAT is a requirement of the European Union (EU), and as the UK is a member nation of the EU, UK businesses have to add VAT to the prices they charge for goods and services. A business must register for VAT if it has sales above a certain limit, but smaller businesses may voluntarily register for VAT and may derive some benefits from voluntary registration.
Voluntary VAT registration may be beneficial for businesses with sales totalling less than the current mandatory threshold for VAT registration of £70,000. Customers may feel more comfortable buying from a business that is registered for VAT as registration suggests to a customer that the business is operating on a larger scale than is actually the case. Some customers may be wary of dealing with an unregistered business, especially via mail order, where the customer has no way of knowing where the business is located, or what sort of premises it occupies, or even if it is a real business at all. VAT registration demonstrates to a customer that the business has dealings with Her Majesty's Revenue and Customs service, or HMRC, which administers and collects VAT, and other businesses are more likely to extend credit to VAT-registered, new businesses, because of this added business credibility.
You may be able to improve profitability by voluntarily registering for VAT, because when you purchase goods and services used for business services, including accountant and other professional fees, or goods that you sell on to customers, you can claim the VAT component of those purchases back from HMRC. If you were not registered for VAT, you would still have to pay the VAT component of those purchases, but you would not be able to claim the VAT back.
Some products fall into the category of products that are subject to VAT, but have a VAT rate set at zero by the government, because the government considers them to be essential products. These include clothing for infants and food. If your business sells zero-rated products, you can still claim back the VAT you pay for goods and services, but since you are not collecting VAT on the sales you make, you will receive a rebate from HMRC for all the VAT you pay for goods and services used to run your business.
You may be able to increase your profitability by voluntarily registering for VAT. If your business manufactures and sells products that are zero-rated for VAT, you will not have to collect VAT on your sales and pay this to HMRC. But if the components, or raw materials, of the products that you manufacture and sell include VAT in their purchase prices, you will be able to claim this back from HMRC as a refund when you file your VAT returns. In effect, this means that the purchase price of the products you buy are less than they would be if you were not registered for VAT. If you were not registered, you would still have to pay the purchase price, including VAT, but you would not be able to claim the VAT back.