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January 15th 2011

Impact of VAT rise for Businesses

VAT has risen to 20%, how this VAT rise will impact the economy, and business.

The VAT rise will undoubtedly have an inflationary impact on the UK economy. Although some brand leaders will pass on the VAT increase and may even use this as an excuse to put up prices, we don’t expect all retailers will look to raise prices immediately, so it will be some time before the true impact of the rise will be seen on consumers.

Whilst the VAT rise is expected to have an impact on inflation it should be remembered that a large part of expenditure on essential items is zero-rated. This includes many foodstuffs, children’s clothing and housing. The reduced rate of 5%, which has not increased, applies to domestic fuel, certain alterations to and conversions of residential property, as well as a limited range of other items.

The Impact on Business

The VAT rise has entailed a costly and time-consuming burden on business in changing accounting systems which can be measured in billions of pounds. The fact that business is the government’s unpaid VAT collector is consistently overlooked.

Businesses must maintain their focus on VAT procedures following the VAT rise or risk harsh penalties as we should expect the VAT rise to be permanent.

Unfortunately responsibility for paying and claiming VAT lies solely with business. The VAT system is designed to be neutral for business but it rarely is: the VAT rise is certain to cost more in terms of cash flow and additional VAT lost due to errors.

To remain competitive, businesses can still ‘beat’ the VAT rise, by invoicing for services provided prior to January 4th 2011 at the lower rate of VAT. Similarly, suppliers can be asked to split their invoices for work done before and after 4 January 2010 and apply the lower rate of VAT to work done before the rate change.

With VAT at 20%, one fifth of turnover (not profit) is now at risk if VAT accounting is not correct. Small businesses and start ups in particular need to pay more attention to understanding the VAT accounting rules with this increased risk.

Businesses trading around the VAT registration threshold (currently £70,000) should consider applying early for registration bearing in mind the current delays in processing applications. With the higher VAT rate there is more incentive to take advantage of the various HMRC schemes to simplify VAT accounting such as the Flat Rate Scheme and Cash Accounting.

The higher VAT rate of 20% means more VAT flowing through the business imposing a greater cashflow risk. Companies should pay attention to basic VAT planning in order to stay VAT neutral, for example by issuing invoices on the first day of the VAT quarter rather than the last and claiming VAT back at the earliest opportunity.

For more information or advice on VAT, please visit the Business Link website.