Dear Contractor Doctor,
I am an IT contractor trading through my own contracting limited company. I’ve been registered for VAT pretty much since I started out about five years ago.
However, what with the recession and economic downturn, my fees have dropped substantially in the last year and I think I have dropped below the VAT registration threshold.
Should I deregister for VAT?
Contractor Doctor says:
“HMRC’s rules say that contractors need only deregister for VAT when they have ceased trading or have stopped making VAT-able supplies,” explains James Abbott, owner and head of tax at contractor accountant Abbott Moore. “This may happen when, for example, a contractor’s business is being closed down because the contractor is retiring, or that business turns into a business that lets residential property.”
And according to Abbott, contractors can’t simply leave their contractor limited company dormant and also registered for VAT. He says that if there is still an intention to make VAT’able sales in the future, then HMRC often won’t object to businesses holding onto the VAT registration during temporary breaks.
“However, if you don’t intend to resume trading then strictly speaking you should notify HMRC within 30 days of raising your final invoice,” continues Abbott. “Generally that 30 day deadline isn’t strictly enforced by HMRC, because most businesses that have finished trading delay deregistering because they have VAT they want to reclaim on outstanding expenses, even though the correct approach is make a claim after deregistering by using form VAT 427.
“Businesses have 30 days to register following the end of the month they start making sales over the VAT threshold (£77,000 for tax year 2013/2014) per annum, assuming those sales attract VAT. And register they must, because the penalties for failing to do so are severe,” warns Abbott. “That’s why we recommend all our contractor clients at least look at registering once they are within £10,000 of the limit.”
De-registering is straightforward
When cancelling VAT registration, you must give HMRC the reason why, explains Abbott. But this is not something to worry about as the process is very straightforward and inspectors rarely query why a business de-registers.
“Contractors who wish to cancel their VAT registration can download a VAT 7 form from HMRC’s website. This asks the contractor to explain why they want to de-register and when. The vast majority of requests to cancel VAT registration are generally accepted by HMRC without query, but there are some catches.”
The biggest catch potentially impacting on contractors is that, when deregistering, the contractor must pay the VAT-able value, or the market value, on any business capital assets, such as computers and office equipment.
However, as Abbott explains, for most contractors this is a formality: “If the VAT due is less than £1,000, then the contractor has nothing to pay. So for most contractors who have bought items such as laptops and office equipment with low market resale values, there are no costs for de-registering. Having said that, this is definitely an area where an accountant’s professional expertise is vital, as mistakes can be costly in terms of penalties.”
De-registering – pros and cons
Abbott says that there are many reasons why a contractor may wish to remain registered, even if they are no longer statutorily required to do so. These include:
- Under the flat rate VAT scheme, most contractors are better off
- The VAT on costs, such as accountancy and IR35 contract review fees, can be reclaimed
- Because most contractors complete quarterly VAT returns, they are required to maintain detailed financial records on a regular basis, helping them to maintain high quality ongoing records consistent with the requirements of being a company director and, in many cases, saving on bookkeeping and accountancy fees
- VAT registration makes a smaller firm look larger, because it implies the company has sales of at least the VAT registration threshold.
However, Abbott acknowledges that there are some reasons why contractors may wish to cancel VAT registration at the earliest opportunity. These include:
- VAT is another tax that contractors can get wrong
- Contractors are required to keep ongoing financial records
- Those contractors working in sectors where businesses, or charities, are not VAT registered can appear significantly more expensive.
On balance, for many contractors, maintaining VAT registration can be cash-flow positive and be of benefit to the contractor’s business. But Abbott warns that just because a contractor business has de-registered, VAT can’t be forgotten: “HMRC can still inspect VAT records, and contractors close to the threshold have to keep careful watch that they don’t get caught out overshooting the VAT threshold.”
Contractors who have taken a conscious decision to move away from their contracting into exempt areas, such as residential property letting, or who have overseas clients outside the scope of VAT, may benefit from cancelling their VAT registration; but we would urge most contractors to think carefully and consult their accountant before making such a move
James Abbott, Abbott Moore LLP
Abbott concludes: “Contractors who have taken a conscious decision to move away from their contracting into exempt areas, such as residential property letting, or who have overseas clients outside the scope of VAT, may benefit from cancelling their VAT registration; but we would urge most contractors to think carefully and consult their accountant before making such a move.”
If a business is not already registered for VAT, the compulsory registration limit is £77,000 in the previous 12 months or, more unusually, £77,000 in the next 30 days. If a business is already registered then projected VAT’able turnover has to be less than £75,000 (the de-registration threshold) for the next 12 months. All rates are current at the time of writing and subject to change.
Good luck with your contracting!