Reducing Your VAT Bill (Legally!)
While residential property is VAT exempt, Serviced Accommodation income – as a form of business income – is not. This means that once you hit the VAT threshold (currently £85k turnover per annum), you need to start charging VAT on your bookings. VAT probably causes more issues with mentees than any other, so we thought it’s about time we look at the issues and options surrounding VAT. We’re specifically going to explore 4 ways that, with foresight and careful planning, you can legitimately use to reduce your VAT bill.
1 – Flat Rate Scheme
Calculating the VAT you pay is relatively simple – you deduct the VAT you paid on purchases, from the VAT you received from customers. However for small businesses, this can increase paperwork and costs, and in 2002 the government introduced a simple alternative. Rather than making this calculation, businesses can instead choose to pay a set percentage of their total income to HMRC as their VAT contribution. This set percentage varies from industry to industry and is based on industry averages so as to work out roughly the same amount but with less red tape. The percentage for “Hotel or Accommodation” is 10.5%, with an additional 1% discount for your first year on the scheme.
As serviced accommodation operators, we are much less likely to have a significant amount of VATable supplies when compared to hotels. Because of this, it means that most serviced accommodation operators will pay less VAT if they sign up to the Flat Rate scheme. If we look at a quick example:
- TOTAL SA INCOME: £12,000
- No VAT Income: £12,000
- Standard VAT Income: £10,000 (£10,000 + £2,000 VAT)
- Flat Rate VAT Income (10.5%): £10,740
So in this particular example, the income net of VAT would be £740 higher on Flat Rate VAT than Standard VAT. To reclaim £740 in VAT, you would need to spend £4,400 on VATable supplies – so almost always, Flat Rate VAT will lead to more income than Standard VAT.
As you are paying a set percentage of your turnover as VAT, clearly you are unable to reclaim VAT for most of your supplies. There are however two notable exceptions to this:
Firstly, even when using the flat rate scheme you are able to reclaim VAT on supplies from before you became VAT registered. You can go back and claim VAT from any VATable services invoiced in the 6 months prior to your date of registration. With goods, you can go as far back as 4 years to reclaim the VAT, so long as the goods are still owned and used within the business. A key learning from this if you are starting out – keep VAT receipts and invoices for all your purchases even if you aren’t VAT registered! If you’ve spent £15,000 on furniture prior to VAT registration, that’s £2,500 you can claim back from your first VAT bill.
Secondly, you can reclaim the VAT for any “capital goods” – e.g. goods which you buy to use within your business, like furniture or laptops – if the invoice total is more than £2,000. Individual items can be much less than this, so long as the total of capital goods on the invoice is more than £2,000. If you are registered for Flat Rate VAT, you might want to think about your purchasing patterns, as ensuring you can reclaim VAT on these purchases will essentially ensure a 16.7% discount on their purchase price.
As the Flat Rate scheme was designed for small businesses, there is an “upper limit” of £230,000 turnover (inclusive of VAT). The upper limit is tested once per year (on the anniversary of joining the scheme), and if your 12 months turnover for that period is over the limit then you must switch to Standard VAT. As the limit is only measured annually, you can still use the flat rate scheme within a growing business to minimise your VAT for a limited time, even if you eventually plan on being over this turnover level.
One important point to bear in mind with Flat Rate VAT, is that the percentage is applied to ALL turnover within the business – even exempt and zero-rated turnover. This is one reason we always recommend a separate company for serviced accommodation, as having to pay VAT on residential income in the same company would make Flat Rate VAT a lot less attractive!
In the Autumn 2016 Budget, the government announced a new “Limited Cost Trader” category for Flat Rate VAT. This was brought in to get around the “Contractor Loophole”, which worked something like this:
- Contractor invoices work of £100,000 plus VAT over a year
- Total invoiced is £120,000 Inc. VAT
- Company paying the invoice can claim back the £20,000 VAT, so it costs them £100,000
- Contractor is Flat Rate registered and so only pays 14.5% to HMRC (£17,400)
- Contractor pockets an additional £2,600 courtesy of HMRC!
The government plans to remove this loophole is by introducing this “Limited Cost Trader” category, which supersedes any other categories if you qualify. You qualify as a “Limited Cost Trader” if you spend less than 2% of your total (VAT inclusive) turnover on VATable goods during any VAT period. This 2% excludes VATable services, capital goods, food and drink.
As Serviced Accommodation operators, there are a number of costs which we regularly incur which will contribute towards the 2%. This includes cleaning supplies, maintenance materials, guest sundries (shampoo, toilet roll, washing up liquid), stationary, and non-capitalised goods (such as kettles and small electrical items). To put it into perspective, if a property is turning over £2,500 per month then you just need to spend £50 per month on the above items to avoid the “Limited Cost Trader” category.
2 – Focus on Long Stays
VAT is charged normally for the first 28 days of any stay, after which there is no VAT on the “accommodation” aspect of the service. For long stays, this can greatly reduce the amount of VAT payable.
For VAT purposes, we must decide what proportion of our rate is for accommodation, and what proportion is for service (e.g. cleaning and linen). As there is no VAT on the accommodation aspect, we clearly want to minimise the service cost without it being unrealistic. HMRC specify you must apportion at least 20% your rate to services, so this is the sensible figure to stick with.
If we consider an example of an apartment with a daily rate of £100, £80 is apportioned to accommodation and £20 to the service element. On the first 28 days of any stay, £467 VAT will be payable, as VAT is due on the full £100 per night. On the second 28 days of the stay, only £93 VAT will be payable, as VAT is only due on the £20 per night service element of the rate.
It is possible to build a strategy focusing on longer-term bookings of 3-6 months, where guests would be unable to get a residential property but still want the freedom of staying somewhere that feels like home. In order to meet your rates, it will need to be the more affluence customer segments, and corporates can be an excellent source of these type of bookings.
An important point to note is that this does NOT apply when you are registered for the flat rate scheme. The flat rate percentage applies to all income, including exempt and zero-rated income, so there is no reduction in VAT.
3 – Use alternative models
Probably the easiest way to reduce your VAT bill is to look at some of the alternative models we discussed in Episode 1 of the podcast.
While for guaranteed rent deals the income will be in your name, for joint ventures and agency/management deals the income would normally be in the name of the landlord. In essence, you are operating in the same way that a letting agent does for residential property – taking money on the landlord’s behalf, dealing with the day-to-day management of the property, and settling payments to the landlord as appropriate. You then invoice the landlord for your services – either as a set percentage of the turnover in the case of an agency deal or as a percentage of the profit in the case of a joint venture.
As a result, their VAT status and not yours applies to the income from the property. If the landlords SA income is below the VAT threshold, they can remain non-VAT registered and so VAT will not be payable. If you as a managing agent are VAT registered, VAT will still apply to your invoice, but this is clearly less than if it applied to the entire turnover of the property.
With careful planning and structuring, you can use this to your advantage. Many of our mentees have found it is not profitable to scale a guaranteed rent business due to the impact of VAT. Instead, they are now targeting landlord joint ventures or agency deals with smaller landlords in order to scale up their business and remain profitable.
4 – Joint Ventures
One thing many people say is “Can I just have one company for me, and one for my partner in order to stay under the VAT threshold?”. The answer is a definitive NO – HMRC would view this as artificial separation and could come after you with a huge VAT bill. It’s really not worth the risk, so please don’t consider doing this!
The only case where you can do this legitimately is when there is a genuine joint venture with different parties involved in the business as shareholders and directors. This is something you should be very careful about – going into business with someone is a huge commitment, and particularly if you plan to purchase assets is essentially a “financial marriage”. Just as you would (hopefully!) not marry someone after a couple of dates, your relationship should be fairly mature before you consider starting a business with someone!
Assuming that your new business is set up with separate shareholders to any previous business, it will have a completely separate VAT status allowing you to start again with no VAT payable until you hit the VAT threshold.
These are the four key ways you can legally reduce your VAT bill – the flat rate scheme, long term stays, alternative models and joint ventures. The common theme is that you need careful strategic planning, taking into account how you want to grow the business in order to ensure you minimise your VAT liability. This (along with corporate structure) is one of the areas our mentees struggle with the most, so if you’d like some help please don’t hesitate to reach out to us!