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Can the VAT cash accounting scheme help my cash flow?
Standard VAT accounting
Typically, you pay VAT to HMRC based on invoice dates rather than payment dates.
Example 1
CRM Limited has built a cloud-based CRM platform that enables organisations to increase their sales by improving customer experiences and providing data insights. The company has annual sales of £750,000 and its next VAT accounting period ends on 31 March 2024 (and every 3 months thereafter).
CRM issues an invoice for £15,000 plus VAT of £3,000 to a new customer on 15 March 2024. The customer pays the invoice on 1 July 2024.
The invoice dated 15 March 2024 falls within the VAT quarter end 31 March 2024 so CRM needs to pay the £3,000 of VAT to HMRC by 7 May 2024 – nearly 2 months before receiving the cash from the customer.
VAT cash accounting scheme
The cash accounting scheme allows VAT to be paid only when you receive payment from customers and when you pay suppliers.
Example 2
Assuming all the facts in Example 1 are the same, except CRM Limited has joined the cash accounting scheme, the company would not need to pay the £3,000 VAT liability to HMRC until 7 November 2024. Under the cash accounting scheme CRM holds the £3,000 of VAT in its bank account for over 4 months before this needs to be paid to HMRC and has the opportunity to earn interest on this balance until the VAT liability is paid in November.
The examples above show the possible benefit of joining the VAT cash accounting scheme but the scheme may not help everyone (it will depend on how quickly your customers pay you and how promptly you pay your suppliers) and the scheme is not available to everyone.
Eligibility
You can use cash accounting if:
- You are VAT registered; and
- Your expected taxable turnover for the next 12 months is £1.35m or less.
You are prohibited from joining the scheme if any of the following apply:
- You are using the VAT flat rate scheme (the flat rate scheme has its own cash-based method); or
- You are not up to date with your VAT returns or payments; or
- You have committed a VAT offence in the past year.
When your taxable turnover is more than £1.6m you must leave the scheme.
Benefits
- Improved cash flow management. If you offer your customers credit, or if they take a long time to pay, then this scheme could be beneficial to you. You only pay Output VAT when you receive payment from your customers.
- You avoid paying VAT on bad debts. Whilst it is possible to claim to reclaim VAT on bad debts if you are outside the cash accounting scheme, there is a timing issue and so the cash accounting scheme means you are never out of pocket if a customer defaults.
Drawbacks
There are some transactions for which standard VAT accounting must be used, or where the standard VAT accounting may be more beneficial. These are the most common scenarios we see in the Tech sector:
- Input tax cannot be reclaimed until you pay your supplier. If you have extended credit terms with suppliers then the scheme may not benefit you because you would be able to reclaim VAT more quickly using the traditional VAT accounting method. We recommend modelling both your Input VAT and Output VAT position to assess the overall outcome for your business.
- Where the payment terms on an invoice are 6 months or more you cannot include these transactions. This prevents VAT from being reclaimed before a good or service has been supplied.
- Transactions relating to goods imported to Northern Ireland are excluded.
- If your customers pay you quickly then there would be little difference between the invoiced-based and cash-based schemes.
- If you mainly make zero-rated supplies e.g. you export goods outside the UK, then the cash-based scheme is unlikely to benefit you.
- If you are a start-up and in a VAT repayment position it could be more beneficial to defer joining the scheme until you start selling to customers.
- Those in the service industry, who make continuous supplies of services to their clients, can already benefit from cash accounting by issuing pro forma invoices and only accounting for VAT (and issuing proper VAT invoices) when payment is received. Thus, cash accounting generally helps suppliers of goods rather than suppliers of services, although some small businesses in the service industry sector can benefit.
- There are additional record-keeping requirements if you use the scheme e.g. you must clearly cross-reference payments made and payments received to corresponding sales and purchase invoices. Using bookkeeping software can help you manage this aspect more easily.
Joining the VAT cash accounting scheme
You do not have to inform HMRC you use cash accounting but you can only join at the beginning of a VAT accounting period e.g. if you are using standard (invoice-based) VAT accounting in the quarter ending 31 March 2024, you cannot use cash accounting until 1 April 2024.
Leaving the VAT cash accounting scheme
You can leave at any time but if you no longer meet the eligibility criteria you must leave the scheme. You should leave at the end of your VAT accounting period (usually the end of a calendar quarter).
There is no requirement to inform HMRC that you are leaving the cash accounting scheme but you must report and pay any outstanding VAT – even if your customers have not paid you - although it may be possible to repay the outstanding VAT over 6 months.
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If your customers take a long time to pay you then you could benefit from joining the cash accounting scheme.
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