Contractor guide to the VAT cash accounting scheme

Value Added Tax (VAT) can be the unsung hero to many independent professionals starting out. Quite simply if you are VAT-registered and incurring costs through goods or services, you can reclaim the VAT applied.

So let’s breakdown the options available and why many newcomers to contracting continue to opt for the VAT Cash Accounting Scheme, writes Christian Hickmott, CEO of contractor accountancy firm Integro Accounting.

When should VAT be applied?

VAT should be applied for when your business turnover exceeds/or is expected to exceed £85,000.

VAT costs are usually paid on a quarterly basis. The standard rate applied is 20% (selective goods and services i.e., power bills may be charged at 5% or some goods such as children’s clothes can have 0% VAT – always consult a professional if you are ever unsure). The most common supplies that are subject to VAT include:

• Sales of goods and services
• The hire or loan of your goods
• Commission
• The sale of business assets

What are the advantages of being VAT registered?

Many choose the option to ‘voluntarily’ register for VAT for the following reasons:

1. You can claim back the 20% claimable VAT expenses you raise for the goods and services provided.
2. Your company can appear more ‘reputable’ – you are issued a company VAT number which can be used on invoices raised.
3. VAT can be backdated up to four years, meaning you can reclaim VAT on what you could have claimed pre-registration.

What VAT schemes are available from HMRC?

Dependent on your trade and circumstances, you may decide to apply for one of the following VAT schemes – these can be applied for by the individual (or any qualified accountant on the individual’s behalf):

• Standard VAT Scheme
• Flat Rate VAT Scheme
• Cash Accounting Scheme

Previously, we have explored the first two of these  for ContractorUK readers in VAT as a limited company: Value Added Tax overview for PSCs. But now, here, let’s delve into why many independent professionals opt for the Cash Accounting scheme.

What is the VAT cash accounting scheme?

To understand the cash accounting scheme, we must explain the standard VAT scheme first.

Standard VAT Scheme work: quick refresher

On the standard VAT scheme, you will apply standard VAT (usually 20%) to your invoice. Once that invoice is raised, the VAT will apply within that business quarter, i.e., when the invoice was raised. This is regardless of whether you have received payment for those goods or services.

How does the VAT cash accounting scheme work?

As with the standard VAT scheme, on the cash accounting scheme you would raise the invoice for goods or services provided.

You will then log that invoice within your bookkeeping system, but key difference – you will not be required to pay VAT until payment has been made in return. Ultimately, you are not incurring any costs from goods or services provided, until that person/client has indeed paid.

Contractor example: Mr A. N. Other coder provides IT services through his company. He and the end-client are VAT registered. He charges standard VAT, at 20%, on his invoice raised in March. The client however doesn’t pay until April; therefore, Mr Other will not be required to pay VAT until the next business quarter April-June, regardless of the invoice being raised in March.

Many independent professionals will use bookkeeping software, such as FreeAgent, to maintain and run their business. For the above example, should you be using the VAT cash accounting scheme, you are able to notify this within the system and it will be factored in accordingly to ensure your payments are allocated against the correct quarter.

What are the advantages of the VAT cash accounting scheme?

Many choose this optional VAT scheme from HMRC when needing to register for VAT for the following reasons:

1. You only pay VAT once your client has paid your invoice - as the VAT returns are based on a cash basis rather than an invoice basis. It is factored as to when your income comes in and out rather than when your ‘bill’ is raised.
2. Greater understanding of your cashflow and an overview on the state of the business.
3. Manages expectations from slow paying clients – you do not forego the cost of the VAT claim until they have paid – and vice versa from the client.

Who can use the VAT cash accounting scheme?

Whether you are a sole trader, self-employed or a limited company contractor, you can apply for the cash accounting scheme.

There is no minimum threshold amount that needs to be reached, quite simply if your turnover reaches £1.35 million or over, you are then no longer eligible for the scheme. 

Can you use the VAT cash accounting scheme in conjunction with the other VAT schemes?

The simple answer is no. The two schemes work completely differently as the Flat Rate VAT Scheme has its own cash-based turnover option. 

For the FRS, you pay one fixed rate of VAT – usually around 16.5% - of your turnover, and then keep the difference between what you charge compared to what you pay to HMRC.

This simplifies admin for contractors as you do not need to record how much VAT you pay on every purchase. You must apply the VAT on each invoice but cannot claim VAT on purchases separately as this is factored into your flat rate percentage.

Can I de-register from the VAT cash accounting scheme if my circumstances change?

Yes. Should you decide to instead use the standard VAT scheme or FRS, you can simply change to this option. You can do this at any time.

However, bear in mind when you leave the scheme, it is advisable to sync this with the end of your VAT quarter to avoid messy calculations, unwanted arrears and with increasingly popular Making Tax Digital software, it is much more complicated to amend figures if needed!.

Lastly, it’s good to talk

Our final recommendation? Always base the decision of which VAT scheme works best for you on your circumstances, trade, and future predicted turnover. But equally important – don’t do it alone! Always speak to a professional accountant to talk over your likely decision, and net some up-to-the-minute, tailored advice to boot!