Unregistered suppliers and VAT

September 8th 2021

You need some building work done at your office, but your preferred supplier is not registered for VAT. This means that it will not be able to reclaim input tax on materials, increasing the final bill to your business. Is there a solution? Bob Johnstone takes a closer look.

Frozen VAT threshold
Even though the VAT registration threshold has been frozen at £85,000 since 2017, which will continue to be the case until at least 2024, many businesses are still outside the VAT net and therefore do not charge VAT on the goods or services they sell. If your business cannot fully claim input tax, perhaps because it is exempt or partly exempt, it makes sense to use non-registered suppliers. But this is not always a good outcome if your business is VAT registered and can fully claim input tax.

For example, if you own buy-to-let residential properties, it makes sense to use unregistered builders and professionals because your rental income is exempt from VAT and you cannot claim input tax.

The materials trap EXAMPLE
For example, your unregistered builder is going to charge you £10,000 for installing a new central heating system and boiler at your office. The labour charge is £2,500, which means that £7,500 must be for materials. It is likely that the builder will make a mark-up on the materials, so the cost breakdown could be as follows:

– Material cost paid to builder merchant – £5,000 + £1,000 VAT = £6,000
– Mark-up on materials – £6,000 x 25% = £1,500.
– If your builder was registered for VAT, the material cost would be £5,000 because they could claim input tax and, with a 25% mark-up, the charge to your business would be £6,250 rather than £7,500.
– You could simply decide to use another builder instead who is registered for VAT.

Is there a solution?
You could agree with your builder that you will liaise directly with the merchant and buy the central heating system, and your contract with the building company will only be for labour. As long as this outcome is clearly reflected in the terms and conditions of the deal between the various parties, and the merchant obviously invoices your business directly, you can reclaim input tax of £1,000 on your VAT return.

However, if your business is partly exempt, i.e. making both taxable and exempt supplies, then the input tax on your office costs will be residual input tax and only partly claimable, based on your usual partial exemption method.

Builder mark-up
Your builder might be reluctant to agree this approach because they will be losing the mark-up they would have made on the materials, i.e. £1,250 in the above example. You could agree to still pay this amount to achieve the VAT saving. The builder might welcome your proposal because it means the total sales figure from your job is being reduced from £10,000 to £3,750. This reduced figure will help to keep them below the £85,000 VAT registration threshold if they are getting close to it.

Consider buying materials directly from a supplier so that you can claim input tax. The builder will then supply only labour to your business. You must ensure that the terms and conditions reflect this outcome, and the merchant must invoice your business for the materials and not the building company.