VAT Cash Accounting Explained

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vat cash accounting
vat cash accounting

What is VAT cash accounting?

VAT cash accounting is one of a number of ways VAT registered companies can calculate their VAT liability.

The VAT cash accounting scheme follows the same principles as cash basis accounting. It means businesses pay VAT on sales when they have received payment for the sale, and can only reclaim VAT once payment has been made to a supplier.

Difference between VAT cash accounting and accrual accounting

VAT cash accounting differs from accrual accounting, where companies have to account for VAT on sales when the invoice is raised or received, regardless of when the invoice is paid.

Accrual accounting is mandatory for businesses with a taxable turnover of more than £1.35 million, and is also generally used by larger businesses with a higher turnover and the cashflow needed to settle VAT liability before invoices have been paid.

Who is eligible for VAT cash accounting?

A number of eligibility requirements apply to the VAT cash accounting scheme.

It is only available to companies with, or with reasonable grounds to believe they will have, a VAT taxable turnover of £1.35 million or less in the next 12 months.

The company must also not be behind with VAT returns or payments or have committed any form of VAT offence, such as VAT tax evasion, in the last 12 months.

Exceptions to VAT cash accounting

A number of exceptions also apply to the VAT cash accounting scheme. This includes when importing or exporting goods to and from the EU, transactions with payment terms over six months, VAT invoices that have been raised in advance of providing goods or services and goods bought or sold under lease, hire-purchase agreements, credit sale or conditional sale agreements.

In these cases, the standard VAT scheme would be used.

Joining the VAT cash accounting scheme

There is no registration process for the VAT cash accounting scheme, and companies do not have to inform HMRC that they are joining or adopting this method of VAT accounting.

It is however only possible to join (or leave) the scheme at the start of a VAT accounting period.

In practice, most smaller businesses will adopt this method after registering for VAT.

There is the flexibility to change scheme, but this can only be done either:

  • At the start of a VAT accounting period, or
  • As soon as annual turnover reaches £1,600,000

VAT accounting rules

Under the cash accounting, VAT (‘output tax’) must be accounted for as soon as payment is received. The following rules apply:

Payment method Date received/paid
Cheque Date the cheque is received or, if later, the date on the cheque.
Credit/debit card Date of the sales voucher.
Standing order/direct debits Date the bank account is credited.
Part payments Allocated to VAT by making a fair and reasonable apportionment, in order of invoice date (earliest first).

 

VAT cash accounting record-keeping

As with all aspects of accounting, sound record-keeping practices are necessary to ensure correct calculations of tax liability are made and to respond to any HMRC request for documentation.

For VAT cash accounting, this means maintaining and retaining a log of all payments made and received, with a separate column for VAT and a reference to the relevant sales/purchase invoice. This is in addition to retaining copies of VAT invoices.

Pros & cons of VAT cash accounting

VAT cash accounting offers a number of practical advantages. Businesses can benefit from improved cash flow since VAT is only payable to HMRC on income received, and not in respect of unpaid invoices. This is particularly helpful where businesses have customers that are slow to pay or where the business is experiencing ‘bad debt’ due to non-payment of invoices.

The scheme may also align better to business owners’ focus on cash flow, rather than invoiced amounts.

Conversely, businesses are only able to reclaim VAT on purchases when they have paid the supplier’s invoice. This can be problematic for businesses buying a lot of stock on credit, such as startups.

 

Legal disclaimer

The matters contained in this article are intended to be for general information purposes only. This article does not constitute tax, financial or legal advice, nor is it a complete or authoritative statement of the rules and should not be treated as such.

Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.

Before acting on any of the information contained herein, expert tax, financial, legal or other advice should be sought.