Limited company contractors just starting out, or experienced contractors returning to contracting after a break in a permanent role, may have to issue VAT only invoices during their first few months of trading, and ensure the pre-VAT invoices they issue include the correct information.
This is because applying for a VAT registration number from HMRC to both reclaim VAT on their business expenses and charge clients VAT can be a lengthy process, taking up to two months.
Some contractors may have been trading and issued several invoices during that period without a VAT number and with no VAT charged. HMRC will backdate the VAT registration date so that some of these invoices will be liable for VAT. To reclaim this VAT from agencies and clients, contractors must issue a VAT only invoice.
How to invoice before the VAT registration is complete
HMRC prefers businesses issuing invoices prior to the VAT registration coming through to issue a pro-forma invoice. These include the contractor’s fees plus the VAT, and then be re-issued and paid when the VAT number actually arrives.
However, undergoing several months without pay is not an option for most contractors, particularly those just starting out. Under these circumstances, the contractor can issue an invoice without VAT to be paid by the client or agency according to the terms agreed.
HMRC’s rules say that VAT invoices must include certain details:
- A unique invoice number and the invoice date
- The contractor’s company name and address
- The client or agency’s name and address
- A description of the services provided.
A fully compliant VAT invoice should also include the contractor limited company’s VAT registration number, the amount of VAT charged and the rate used. However, this is not possible if the contractor has not yet received their VAT number.
State ‘VAT registration pending’ to avoid being out of pocket
The solution is for the contractor to issue invoices that include the information above, plus their fees and state clearly on the invoice that VAT registration is pending.
This is essential because a contractor could issue an invoice with no VAT and without stating that VAT registration has been applied for and is pending. Then a backdated VAT registration could arrive confirming that the invoice is covered within the period that the VAT registration starts, and so be liable for VAT.
The vast majority of agencies and clients, if in receipt of an original invoice stating 'VAT registration pending', will pay a VAT only invoice a few weeks or months later, when the contractor's VAT registration arrives
The contractor could then try to reclaim the VAT from their agency or client, who could in turn say ‘no, there was no VAT on your original invoice nor any indication that we would have to pay VAT, so we won’t pay it’.
The contractor must still pay the VAT to HMRC, because the invoice falls inside the period from when VAT registration started. So if the client or agency refuses to pay any VAT, then the contractor’s company is liable to make up the difference and pay 20% of the fees invoiced to HMRC, meaning the contractor takes a 20% hit on their fees.
Creating a VAT only invoice
Fortunately the vast majority of agencies and clients, if in receipt of an original invoice stating ‘VAT registration pending’, will pay a VAT only invoice a few weeks or months later, when the contractor’s VAT registration arrives.
Creating a VAT only invoice is straightforward – see the example below and download a VAT only invoice template. Each invoice must include:
- The same invoice number, date and address information as detailed above
- The new VAT registration number, which must now be added to all invoices
- A description of the services to which the VAT applies
- The prevailing rate (currently 20% for typical contractor services)
- The actual VAT amount.
Once this VAT has been paid by the client, the contractor can process the payment in their first VAT return, which will include all the fees earned since the registration date and the VAT paid by clients, less the VAT incurred by the contractor’s company on goods and services.
50 Software Drive
London E1 3FR
Tel: 0208 555 555
VAT: Registration applied for
||ABC001 - VAT Only
||01 January 2014
||01 February 2014
|VAT Only Invoice:
||Contracting Services - Oct 2013
||Contracting Services - Nov 2013
||Contracting Services - Dec 2013
||VAT @ 20%
||Payment within 30 days.
Money transfer to the account below:
Wicked Solutions Ltd
Sort Code: 20-21-22
Account No: 12345678