Value Added Tax (VAT) is a crucial part of the UK tax system, and it impacts self-employed individuals since they are obliged to comply with the HMRC VAT regulations if their business meets specific criteria. Moreover, being self-employed, if your business is VAT-registered, you must charge VAT on all the goods and services you are selling to the consumers, you can reclaim VAT on certain business-related expenses, and you must file VAT returns. More crucially, to charge VAT, you must first know how to calculate VAT as a self-employed individual.
Hence, in this guide, we will list all the necessary steps involved in understanding how to calculate VAT as a self-employed individual so you can gain a firm grasp on VAT and ensure compliance with HMRC regulations.
Further, to learn whether your business as a self-employed stands eligible for VAT registration or not, read our extensive guide on How to register for VAT as a self-employed.
How to calculate VAT as a self-employed individual?
VAT is a sales tax that VAT-registered traders or businesses add when selling most products and services in the UK.
When the amount of your annual earnings or turnover that your business can generate surpasses the VAT threshold, its registration for VAT becomes obligatory. Notably, the current VAT registration limit for the 2024-2025 tax year is £90,000.
Now, the following steps would elaborate on how to calculate VAT as a self-employed individual:
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Determine the appropriate VAT rate to charge:
As a sole trader, when you reach the VAT threshold, you must begin charging VAT on any applicable products or services you sell to the consumers. Likewise, being independent, you will also be liable for reporting VAT to HMRC yourself by including the VAT on your invoices.
Now, as for how you would determine how much VAT is to be charged to the customers, you will simply have to identify the category your goods or services fall under and apply the appropriate VAT rate. For instance, the following are the VAT rates and the categories of the products they are applicable to:
Standard rate (20%):
This rate usually applies to most goods and services in the UK)
Reduced rate (5%):
The reduced rate is charged on certain goods and services, such as mobility aids, home energy, and children’s car seats.
Zero rate:
This is a 0% rate tax, wherein any items falling under this rate are VAT-exempt. It is reserved for essential items, such as food, children’s clothing, books, and certain public transport.
Usually, the standard rate (20%) is applicable for the vast majority of sole traders. Yet, it is prudent to keep visiting the government page time and again to ensure you are applying the accurate and up-to-date VAT rates.
Charge the correct VAT rate:
Once you determine the VAT rate, it is time to charge VAT. For your ease of understanding, we are going to list all the steps on how to add VAT rate to the applicable goods or services:
Determine the net price:
Consider you are to apply the standard rate of 20% VAT to your goods and services. First, you will determine the net price, which is the price of the goods or services before VAT is charged.
Calculate the VAT:
Second, you will multiply the net price by the VAT rate of 20%.
For instance, suppose the net price is £100.
Then,
VAT = £100 x 0.20 = £20.
Calculate the Gross Price:
Third, you will calculate the total or gross price. You can get the gross price by adding the VAT amount to the net price. To illustrate,
Gross Price (Total price) = Net Price + VAT = £100 + £20 = £120.
Charge the customers:
As an outcome, if you are selling a product for £100, you would charge the customer £120 for that product, meaning it includes £20 in VAT.
Maintain accurate records:
It is greatly emphasised that you must ensure that the net price of the product or service and the VAT amount are displayed on your invoices to comply with regulations. Similarly, you must include VAT information on all the invoices generated for each sale.
Beyond that, the invoices must show VAT charges as a separate part of the total cost. It is also mandatory that you provide your VAT number on the invoice and mention the transaction in your VAT account.
Lastly, while completing your VAT returns, you must also keep a record of the amount on each VAT return.
Notably, considering how crucial it is to keep a record of all your transactions and VAT costs, it might become laborious for you to remain mindful of how to calculate VAT as a self-employed.
More importantly, keeping track of your VAT costs across multiple invoices can be a nerve-wracking task to carry out if bookkeeping is not your cup of tea. Therefore, you can never deny the importance of bookkeeping for VAT-registered businesses.
Therefore, to streamline your VAT cost tracking and record keeping, an accountant can do more than just bookkeeping. For greater clarity, a certified accountant, such as those listed on Accountingfirms, can produce financial statements, provide comprehensive and personalised tax consultation, and offer worthwhile strategic financial insights. Hence, an accountant can simplify the accounting process for the self-employed.
Pay the VAT you owe to HMRC:
After all the calculations and charging correct VAT costs, you are now to fulfil your VAT obligation to HMRC. To go into detail, you must pay the VAT you charged and collected from customers.
Nevertheless, you can viably deduct any VAT you have paid on eligible or allowable business expenses. Even if you do not deduct it earlier, you can reclaim the allowable expenses later from HMRC.
Now, it is noteworthy the VAT amount a sole trader pays or reclaims from HMRC consists of the difference between the VAT amount it charges to its consumers and the VAT amount it pays on its own purchases from suppliers, i.e. The VAT you pay to HMRC is the difference between the Output VAT and Input VAT.
Thus, you must first know and calculate the output and input VAT.
Calculate Output VAT:
The output VAT refers to the issued invoices or the VAT charged to consumers. Alternatively, Output VAT is the VAT you have collected from the customers.
Next, you will sum or add up all VAT you have charged on your sales.
Calculate Input VAT:
On the contrary, input VAT refers to the received invoices or the VAT paid on purchases. Alternatively, input VAT is the VAT you have paid solely on your business-related expenses. You will need to calculate all the input VAT you have paid on business goods and services. It is worth pointing out that you must have all the valid VAT invoices for claims.
Calculate the VAT owed:
Once you have calculated the output and input VAT, you can easily calculate the VAT you are to pay to HMRC.
You can understand the calculation of VAT with the help of the following example:
Output VAT= VAT you have collected from customers = £2,000
Input VAT= VAT you have paid on business expenses = £500
VAT you must pay to HMRC= Output VAT – Input VAT = £2,000 – £500 = £1,500
Reclaim VAT from HMRC, if applicable:
Fortunately, while you can charge VAT on your sales, you can also reclaim VAT on your purchases.
For instance, if a sole trader has charged more VAT to customers than they paid on their business expenses, they must pay the difference to HMRC. In contrast, if a business pays more VAT than it charges its customers, it can reclaim the difference from HMRC.
Thus, if your input VAT is higher than your output VAT, you can claim a refund from HMRC.
Summary:
The gist of the entire discussion is that regardless of what type of self-employed you are, VAT will remain an unavoidable obligation after determining your eligibility for VAT registration.
Self-employed individuals usually execute all their business tasks independently without having to worry about employing an in-house staff to get to grips with the business responsibilities on their behalf.
Therefore, it is of utmost importance that you learn how to calculate VAT as a self-employed individual. However, a self-employed individual can appoint a director to help manage and perform their business operational tasks if they choose to form a limited company.
Alternatively, you can appoint a skilled and well-versed accountant for VAT registration, submission of your VAT Returns and deal with HMRC on your behalf.
Accountingfirms can be your one-stop solution if you are in the pursuit of a competent, affordable, and nearby accountant based on your location in the UK.
Thus, contact us today and let the financial experts take the stress away from fulfilling HMRC VAT obligations from you.
Disclaimer: The information provided on AccountingFirms.co.uk is for informational purposes only and should not be considered as financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.