An Introduction to what VAT is, that is my topic in this weeks I Hate Numbers podcast.  In this series of podcasts, I am going to look at what VAT is and how it affects your business.

Are you a business owner and want to know more about VAT?

What is it, how does it affect your business, and what's the system like? If so, then this podcast will be perfect for you. In this first part we'll look at what VAT is, why businesses need to pay it and how they do that.

Listen now to find out more.

So in let's start with what is VAT? Well, value added tax or to give it its correct name is a form of consumption tax which means that it's paid when goods and services are bought and sold rather than when they are produced like income tax for example. It was introduced in 1973 as part of a move towards taxing expenditure rather than income but has been around in various forms since 1932 under different names such as purchase tax or turnover tax depending on where you lived at the time.

Roles and responsibilities of VAT registered businesses

Do you have a business? Are you registered for VAT?

If so, then you are part of the millions of unpaid tax collectors employed by the government in the UK and around the world.  You join them as soon as your turnover reaches the registration limit, currently £85,000 over the last 12 months.  VAT is collected on behalf of HMRC by businesses that are registered for VAT.

In general it does not affect your profitability but there may be some exceptions to this rule depending on what type of business you run and how much turnover you have.

Conclusion

Moreover, if you worried, confused, or need help with understanding VAT, you’re not alone. In fact, many businesses find themselves in the same situation.  This podcast on An Introduction to what VAT is will help.

Listen to find out more.

My mission is to inform, inspire and educate you to get closer to your numbers. You can make more profits, save tax and time, improve your well-being and your money mindset.

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Firstly, what is VAT? VAT, or very awkward tax, as I like to call it, confuses and scares many business owners. Fear not. I'm going to talk to you about what VAT is, how it affects your business, and introduce you to how this system works. This is part one of a series that will set the scene, give you an overview about VAT to set yourself on the right track.

You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now. Here's your host, Mahmood Reza

In this podcast, I'm going to look at what VAT, or to give it its correct name, value added tax is, how VAT affects your business, and how the VAT system works. There will be an illustration later on in the podcast with numbers to make it easier to understand. VAT principles are straightforward. The application and the rules, however, are not always so.

Let me share some good things to know about VAT. VAT is operated in over 160 countries around the world, and in the UK alone, it brings in around 134 billion pounds worth of revenue into the government coffers. The administration and collection of the tax is done by VAT-registered businesses. The tax is ultimately paid by consumers and businesses not registered for VAT.

VAT-registered businesses add VAT to the price they charge for their goods and service. What's the role of businesses and responsibilities of business in the VAT chain? Now, when your sales go to a certain level, currently 85,000 pounds over a 12-month limit, then you must register for VAT. There may be many good reasons to voluntarily register for VAT.

Crazy but true. Once you become registered for VAT, you join the millions of unpaid tax collectors employed by the government in the UK and around the world. The only difference is that you get no benefits, no pay, training or holiday pay, and you can only quit your tax collection job when you are no longer VAT registered.

There is no bonus or praise for doing a good job, but mess up innocently or otherwise, and it can cost you. Your business will charge VAT at the relevant rate on what you sell to your customers, and you pay that VAT to your suppliers. The VAT you charge your customers is called output VAT, and the VAT you pay to your suppliers is called input VAT.

Typically, every three months, you'll submit your VAT return form, and pay over to HMRC what you owe them. What you owe HMRC is the difference between your output VAT you charged your customers, and the input VAT that you've paid to your suppliers. Other compulsory duties include record keeping, and a myriad of rules and regulations.

Warning alert. If you don't comply, then it's a possible financial wrap on the knuckles. VAT-registered businesses are collecting the tax on behalf of the tax authorities. Currently in the UK that's called HMRC. There is an investment of your time, your money, and knowledge to operate VAT, but in the main, VAT does not affect your profitability.

Check out the show notes at the end and I'll give you a link to a podcast that was previously done on profitability. Now, let me take you on a journey, sharing a story to illustrate the operation of VAT. I'm going to introduce the characters, and, then, blend in some numbers. My story involves the hospitality sector, but the knowledge is transferable to any sector, or any business.

There are four parties involved in this story: farmer Fred, Bob the brewer, the I Hate Numbers Pub and the I Hate Numbers drinkers. The principles of this story are as follows. Tax collectors will sell their products, add VAT where appropriate at the relevant rate to their prices. The tax will be collected. Deduct any VAT paid to supplies, and the difference is paid over to HMRC.

In addition, all the tax collectors in our chain, in our supply, in our VAT family, will have to maintain suitable and adequate records. More of that next week. Now, the tax collectors in this story are Fred that grows the wheat to sell to Bob the brewer. Bob uses the wheat to brew beer to sell to the I Hate Numbers Pub, and the I Hate Numbers

Pub will then eventually sell the beer to his customers. The pub's customers get to enjoy the beer, but they will pay the VAT on their pint of beer. Now, let's go through and blend in some numbers. Assume a headline rate of VAT in the UK of 20%. Fred, the farmer, sells the wheat for 1000 pounds, and we'll add to that 20%

for the VAT. The total invoice value is 1200 pounds. Of that 1200 pounds, 200 pounds is VAT that the farmer will collect. Put to one side, 1000 pounds is the value of the sale that Fred has made. Bob will then brew the beer and sell that brewed beer to the I Hate Numbers Pub for 3000 pounds. He will add 20% to that invoice, and the total invoice value is 3,600.

3000 pounds is the value of the beer sale. Obviously, Bob has had costs, wants to make a profit margin, so unless he's in a financially suicidal mood, will not sell the beer for the price he’s paid for his ingredients. The pub, the I Hate Numbers Pub, is storing the beer. And, in a typical evening, the bar takings from those beer sales record the value of 6,000 pounds.

So, all the beer that's been sold, 6,000 pounds is the bar takings. This 6,000 pounds includes 1000 pounds worth of VAT. 5,000 pounds is the value of the beer that's been sold by the pub. 1000 pounds has been collected for the VAT from all the customers who've bought beer. Let's summarise and round up what each party has to pay over. Fred,

the farmer, has charged VAT of 200 pounds, Bob has charged 600 pounds worth of VAT, and the pub, I Hate Numbers Pub has charged 1000 pounds worth of VAT. Now, that is not the VAT that will be paid over. Remember what we said earlier in the podcast is that each tax collector is allowed to deduct any VAT paid over to suppliers.

In this example, Fred, the farmer, there's no VAT that he's paid over that we've mentioned in this example. So, Fred will pay over 200 pounds worth of VAT that he has collected. Bob has charged 600 pounds worth of VAT, but he's also paid 200 pounds worth of VAT to Fred, the farmer. So, he compares those two numbers,

takes off the 200 pounds he's paid over, and he will pay over to HMRC 400 pounds of VAT. That's the 600 pounds he's charged, less the 200 pounds he paid to Fred, the farmer, that's 400 pounds he's paid over. Collected, deducted the supply of act, and paid the difference. Now, the I Hate Numbers Pub charged a thousand pounds worth of VAT to its customers,

but it also had 600 pounds worth of VAT it paid Bob, the brewer, for the beer that it purchased, so that 400 pounds is the difference. That 400 pounds is remitted, paid over to HMRC with the accompanying VAT form. It wouldn't be a tax system unless we had forms in there. If we add those up, the 200 pounds from the farmer, 400 pounds respectfully from the brewer and the pub, that's a total of 1000 pounds paid over.

However, the actual real burden is the customer who will ultimately bear the burden of VAT. The VAT burden falls on the consumer, or any business that's not VAT registered. Now, as a handy tip, if you are VAT registered, if your business is involved, then I highly recommend that every time you invoice a customer that you put to one side the VAT that is due.

Now, the headline rate can be at 20%, but put something aside. The money does not belong to you. It belongs to HMRC. Put it into a separate bank account. It's not yours, you're merely collecting on behalf of the government. In next week's podcast, I'm going to look in more detail at the administration requirements.

VAT invoices. What are they? What do they look like? What information must be contained? Claim back the VAT, the VAT return and reverse charging. Folks, I hope you got some value from this podcast. I'd love it if you could share it, comment, feedback. Until next week, have a good week. We hope you enjoyed this episode and appreciate you taking the time to listen to the show.

We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.