VAT Registration is Costing Me Money: A Case Study

Registering for VAT is a big step for any business. While some are forced into it because their turnover has exceeded the threshold for compulsory registration, others choose to register of their own accord. Most business owners think this through extensively before coming to a decision; others, though, presume that VAT Registration is simply ‘the done thing’ and, as a result, rush into it.

This case study concerns a business owner who thought carefully about VAT registration. Having looked back at her previous six months’ records, she decided that her input tax (that is, the money she paid out to suppliers in VAT) was greater than what she would have charged in output tax (that is, the amount she would have charged in VAT during that period).

“It seemed like a good idea. Had my trading patterns stayed the same, I would have been able to continue claiming a rebate on VAT most months,” she said. “As it is, I’m quite severely out of pocket and considering deregistration.”

Tax Investigations

The woman runs a small, specialist retail business in which she adapts costume jewellery and sells it on. She registered for VAT and, as her input tax exceeded her output tax, she claimed a rebate for the first VAT period. “This is really where the problems started,” she said. “The taxman launched an investigation almost immediately.”

All businesses must be prepared for a tax inspection, but there seems to be evidence that HM Revenue & Customs (HMRC) is particularly suspicious of firms and individuals that register for VAT and then immediately claim a rebate.

Although the investigation found that the relevant records were in order, the process took a significant chunk out of the woman’s schedule. “The investigation took about two weeks. I run the business entirely on my own, and I just couldn’t afford to take that much time out.”

Price Discrepancies

Undeterred, the woman continued claiming back VAT on a regular basis. But, after eight months’ trading, the recession hit and she began dropping her prices in a bid to stay competitive. “It actually worked better than expected, in that my sales volumes skyrocketed. I ended up being much more efficient, and using fewer materials.”

While this was good for her bottom line, it had a disastrous impact on her VAT situation. For the first time, her input tax fell as she had to buy fewer materials, and as her suppliers dropped their prices. At the same time, though, her output tax was increasing as she sold more products.

Deregistration

“As it stands I am paying around £1,000 at the end of every VAT period. It might not sound like much, but mine is a very small business and I just can’t afford that. My turnover is still below the threshold, so I plan to deregister.”

Although the woman in question thought through her decision carefully, and has been affected by circumstances outside her control, hers is a cautionary tale for all business owners considering VAT registration. While many businesses may see a positive effect from registration, the potential dangers are not to be ignored. Make sure that you Seek Advice From An Accountant before registering, in order to be confident that you are doing the right thing for your business.