Limited company contractors who are never likely to earn above the VAT sales turnover threshold of £79,000 (the 2013/14 figure) per year, or who supply services that are out of the scope of VAT, may nevertheless choose to be VAT registered. A company does not have to be earning over the threshold to register. And there are pros and cons that mean each contractor must weigh up whether or not to do so.
The advantages of not being registered include less administration, with no VAT returns to complete each quarter, and more competitive hourly and daily rates for some markets, such as within the financial and not-for-profit sectors. However, contractors choosing not to register cannot reclaim the VAT element of their overheads and expenses, and may be perceived by some potential clients as being too small to do business with.
Administration advantages to remaining non-VAT registered
It is compulsory for any contractor limited company earning over the VAT threshold to register for VAT. In fact, the vast majority of contractor limited companies do register for VAT, even if they don’t earn over the threshold, and often opt for the flat rate scheme, because of the financial benefits.
But there are some advantages to non-registration for contracting businesses. The first is the reduction in administration. When a business is VAT registered, it must add VAT to its client invoices, display its VAT number on invoices, secure VAT invoices and receipts for company expenses and submit a quarterly or annual VAT return.
Non-VAT registered companies do not have to add VAT to invoices, obtain VAT receipts for expenses or file VAT returns. However, all businesses, including non-VAT registered contracting ones, still have to maintain detailed and accurate records of invoices and expenses.
Targeting non-VAT registered clients
Contractors who mainly target specific financial sector or charitable organisation clients may also benefit from having more competitive rates. Some organisations are not able to register for VAT, so they effectively pay 20% more for a contractor who is VAT registered than one who is not. For some organisations, such as charities, they can make significant savings by hiring non-VAT registered contractor limited companies.
Many of the organisations affected have found solutions to the VAT registration issue, and use agencies with complex billing structures. Others have commercial arms or other group companies that can be VAT registered, so this contractor advantage can be limited.
Treatment of invoices when not VAT registered
When invoicing clients, contractors simply bill their day rates to the client and nothing more. So, if a contractor earns £250 per day, and has worked 22 days in the month, the invoice to the client is simply 22 x £250 = £5,500.
Contractors who mainly target specific financial sector or charitable organisation clients may also benefit from having more competitive rates
The equivalent with VAT added would have cost the client an additional 20% of £5,550, which is £1,200. A charity could afford to employ someone full-time for the savings it would make over a year when hiring a non-VAT registered contractor.
Processing expenses when non-VAT registered
Common contractor business expenses, such as computers, broadband, mobile phone, travel and subsistence, are usually paid for by the contractor’s company at the gross cost including VAT. VAT will also be charged on most expenses, apart from some travel and subsistence that is zero rated.
Assuming they submit a quarterly return, VAT registered contractor limited companies would have invoiced some VAT during the quarter, and would work out how much VAT was included in the expenses and deduct this amount from the money owed to HMRC.
A non-VAT registered company cannot claim VAT on expenses. So, if a laptop cost £299 inclusive of VAT, that’s how much the contractor’s company will pay. That is also the amount which will appear in the limited company’s accounts, and the amount that will receive corporation tax relief (ie it will be deducted from the company’s profits).
Examples of VAT registered versus non-VAT registered
So, say a contractor paid out £299 including VAT from their own pocket for a company laptop. The contractor would submit an expenses form to their own company for the full £299 to be repaid to them by the company.
The company would include the invoice for the full £299 in its accounts and corporation tax return as an expense at the end of the year. The VAT would remain ‘invisible’.
But if the company was VAT registered, then 20% of the cost of VAT-rated expenses, the amount of VAT included in the price, could be reclaimed from VAT charged to clients.
The table below provides an example of a contractor’s basic quarterly company expenses. It is assumed that the contractor bought a laptop worth £299 including VAT and pays out £30 a month including VAT for their broadband and mobile phone costs.
| Expense | Non-VAT registered contractor | VAT registered contractor (less 20%) |
|---|---|---|
| Laptop | £299.00 | £239.20 |
| Broadband | £90.00 | £72.00 |
| Mobile phone | £90.00 | £72.00 |
| Subsistence | £300.00 | £240.00 |
| Cost to company | £779.00 | £623.20 |
| Saving | £155.80 |
In this example, the contractor gets the train to the client’s site, which is non-VAT rated, but spends £5 a day on lunch, and secures VAT receipts for each meal, so has a £300 subsistence bill (£100 per month for 20 lunchtime meals), which includes VAT.
According to the above comparison, a VAT registered contractor could be better off each month by claiming their VAT. The above expenses are fairly modest, so in practice it is possible to make more substantial VAT savings by being VAT registered.
Making a company appear larger than it is
There is still a perception in the minds of some clients that a company with sales below the VAT threshold is too small to do business with. That irrational but still widely held view is that if a company is VAT registered, then it must be fairly sizeable and not a one person business.
On balance, unless a contractor has some unusual characteristics or a very specific reason for remaining non-VAT registered, the financial and ‘marketing’ benefits of registering tend to make it worthwhile, particularly for those using HMRC’s flat rate scheme.