So, you run an e-commerce business, and you have just hit £85,000 in sales for the last 12 months. Congratulations! Now, you need to register for VAT. Here is an idea of how VAT works: The government has imposed on those in business the unpaid job of being a tax collector, navigating a system so complex that VAT officials themselves often get it wrong. Oh, and also, they impose massive penalties on those who make any mistakes.
VAT stands for Value Added Tax. The basic idea is simple: you add a specific percentage tax to your sales, which your customers have to pay you, and you pay it to the government. If you buy supplies with this tax added to the price, you can reclaim the tax element. Every quarter, a VAT return is prepared, where the tax on sales /outputs/ is added up, and the tax on purchases /inputs/ is deducted from it, and the net result is paid to the government. The Standard VAT rate in the UK is 20%. The trouble with e-commerce is that most of the spending is on marketplace fees, Google or Facebook ads and Etsy or Shopify charges. Generally, these are companies registered abroad, and there is no VAT to claim back. I would not be surprised if more than 50% of your spending is non-reclaimable. Here is a basic example of a Standard VAT scheme:
monthly UK sales £10,0000 = £2,000 output VAT /20%/
Cost of goods sold - £1,500 = -£300 input VAT /20%/
monthly fulfilment- £500 = -£100 input VAT
Etsy fees - £1500 = £0 input VAT
Facebook Ads - £1500 = £0 input VAT
Google Ads - £1000 = £0 input VAT.
Your business has to pay £1600 VAT to HMRC, or 16% of the sales. Therefore, when you become VAT registered, you must increase your Prices by 16% to maintain the same margins. And we know how many retail businesses operate on minimal margins to be competitive on marketplaces. In effect, you are 16% worse off. Let me tell you a trick that will mitigate that impact.
This is a VAT scheme where you pay a fixed percentage of your turnover, and the exact rate varies and depends on the nature of the business. For eCommerce businesses, currently this is 7.5%. Where is the catch? You are not allowed to claim VAT on any of your expenditures, except if it is the purchase of an asset for more than £2000. If we use the same figures as above, it will work out as:
Sales VAT inclusive - £12,000
VAT to pay to HMRC 12,000*7.5% = £900.
You will be £700 better off by using this scheme. You can use the difference to grow your business, develop new products or explore new sales channels. One more thing, if you are newly registered for VAT business in the first year you get a 1% discount, so it will actually be 6.5% for the first 12 months, making it ideal for fledging online shops. And because you are not allowed to claim back any VAT, there is no need for a lengthy paper trail on your purchases and verifying each supplier or subcontractor if they are VAT registered and where in the world.
FRS comes with some limitations: you can not join the scheme if your turnover for 12 months is more than £150k, and if you have joined and your sales go over £230k, you have to leave the scheme and start using standard VAT. Hopefully, by that time, your revenue will be higher and stable, and you will cope with lower margins.
The Flat Rate Scheme for VAT provides a simplified approach to tax compliance, making it an attractive option for many eCommerce businesses. However, it's crucial for entrepreneurs to carefully consider the advantages and disadvantages before deciding whether the scheme aligns with their business model. Seeking professional advice and staying informed about any changes in tax regulations will contribute to a smooth and compliant VAT journey for e-commerce entrepreneurs. It is always necessary to seek professional advice based on your own business setup and specifics. We invite you to book your no-obligation consultation with us.
