VAT for start-up business

There are many things to consider when starting a new business. I often hear people say “I don’t need to register for VAT as I haven’t reached the threshold yet”. This may be true but I have 3 issues with this statement:

1. The test for VAT registration is not whether or not you have reached the threshold, it is whether or not you are LIKELY to reach the threshold in any 12 month period
2. A business may be unnecessarily incurring VAT costs on purchases
3. If you sell to consumers (as opposed to businesses) when you are required to register for VAT you will either have to increase your prices or reduce your margins to take account of the VAT element

There are many factors which should be considered when deciding whether or not to register for VAT:

1. Who are you selling to?
2. Will you incur significant amounts of VAT on start-up costs?
3. What are the compliance costs likely to be?
4. How soon will you reach the registration threshold (if ever)?

Here’s an example:

Joe sets up a business in January. The business is selling widgets to consumers. None of his sales are to businesses. In January he forecasts his annual turnover to be €35,000. He is not required to register for VAT so decides not to.

Joe spends €10,000 plus VAT of €2,100 on new equipment. The cost to Joe is therefore €12,100. As he is not VAT registered he cannot claim this VAT back.

Business goes better than expected and in September he forecasts his turnover for the forthcoming year to be €80,000. He is now required to register for VAT effective from the September/October VAT period. He will be required to charge VAT on all his sales and will be entitled to reclaim VAT on certain business expenses (from 1 September only). Joe charges €10 per widget. Now that he is VAT registered he must charge VAT on sales. He can do this by either:

1. Charging VAT on the €10, ie €2.10 with a total cost to the consumer of €12.10; or
2. Assuming that the €10 is now VAT inclusive, ie the cost to the consumer remains €10. Of that Joe gets €8.26 and Revenue gets €1.74

A difficult decision: increase your price and lose competitiveness or reduce your profitability?

If Joe opted to register for VAT from day 1 he would avoid that difficult decision. Granted he may have some added compliance costs but his purchases would be lower as he could reclaim VAT on these, including the €2,100 VAT incurred on equipment.

Rent is a significant overhead for many businesses.  The VAT rules for property are notoriously complex, however if a landlord charges VAT on rent it could significantly increase this cost.  If the business is VAT registered and entitled to re-claim VAT on purchases it should also be able to reclaim the VAT charged on the rent.

When starting is business the VAT question should be answered before you spend any money. If you make purchases and later decide to register you may not be able to reclaim the VAT on those purchases.