If your business has an annual turnover that exceeds the VAT registration threshold (currently set at £68,000), you are obliged to register for VAT. However, many businesses choose to register voluntarily for financial reasons, before their turnover reaches the threshold.

Why register for VAT?

In simple terms, businesses that are VAT registered can ‘claim back’ the VAT they pay on business purchases. This is why, in business supply catalogues for example, prices are often shown with and without VAT. Clearly, if you are making a lot of purchases that attract VAT, this could save you a significant amount of cash.

However, if you are VAT registered you must also charge VAT on all relevant products. You are then obliged to pay the difference between the VAT you receive (known as output tax) and the VAT you have paid (known as input tax).

This is perhaps best explained with an illustration.

You are a widget sales company. You buy widgets for £5 including VAT, and you sell them on for £10.

If you were not VAT registered you would make a simple £5 profit.

If you were VAT registered you would be able to claim the VAT back from the £5, lowering the cost to £4.35. However, you are then obliged to charge VAT yourself. So you would either increase your sales price to £11.50 and risk deterring customers, or you would absorb the VAT into the price. In this case you would actually make £8.70 from each widget, reducing your profit to £4.35.

You therefore need to think very carefully about whether you are making enough VAT-liable purchases to make registration worthwhile. It is worth going over this with an accountant before making a decision.