In most cases, VAT-registered entities will follow the standard VAT reporting process: the VAT Standard Accounting Scheme. Under this scheme, the taxable person (i.e. entity registered for VAT) keeps a record of all sales and purchases. The standard VAT scheme is a form of accrual accounting. VAT charged and VAT paid is calculated according to the date of the invoice, rather than when the cash is actually received.
Under Standard Accounting, VAT received (output VAT) is compared with the VAT incurred on purchases (input VAT). The calculation of output VAT to input VAT determines how much VAT the business owes tax authorities. In cases where the company expended more VAT on business expenses than it received, it may apply for a domestic VAT refund.
There are also a number of alternative VAT schemes available that could be more suitable for a particular business.
Cash Accounting VAT Scheme
In contrast to Accrual Accounting principles, which are based on the date listed on the relevant invoices, Cash Accounting accounts for transactions based on the date payments actually occur.
The Cash Accounting VAT Scheme is generally used by smaller businesses that may not receive prompt payments.
Flat Rate VAT Scheme
In most cases, the amount of VAT an entity pays is calculated according to the difference between VAT charged, and VAT received. That is the case regardless of whether you apply accrual accounting or cash accounting principles.
The Flat Rate VAT Scheme works differently. With the VAT Flat Rate Scheme, the company pays a fixed rate of VAT, set at a percentage of turnover. Under UK VAT rules, this scheme is only available to entities with a VAT inclusive turnover below £150 000.
Under HMRC rules, a business can only change its VAT scheme at the start of a new accounting period.
However, changing your VAT scheme is about more than notifying tax authorities. You need to change the way your accounting systems process VAT. This can involve significant administrative effort.
For example, changing from accrual accounting (under the standard VAT scheme) to cash accounting requires including all unaccounted sales and purchases, even if they have not yet been paid.
As any errors on your VAT returns could lead to penalties, businesses should ensure they have the VAT software and guidance they need to prevent errors when changing invoice schemes.
