Posted on: 15 March 2026
You’ve been grafting away, building your business, and things are going well. Really well. So well, in fact, that you’re about to cross the £90,000 turnover mark. Which means one thing: it’s time to register for VAT.
For a lot of new freelancers and contractors, VAT is one of those things that feels genuinely foreign. The whole concept can be overwhelming – you register with HMRC, and then suddenly you’re adding 20% to every invoice you send. But where does that money actually go? How does it get handled? And who’s responsible for making sure it ends up in the right place? That’s exactly what this article covers.
TLDR; The VAT that you collect on your invoice payments is not yours. Don’t spend it. That money belongs to the taxman, and they’ll be wanting it soon.
First things first: when do you actually have to register?
The current VAT registration threshold is £90,000 in taxable turnover. That’s been the case since April 2024, and it hasn’t changed for 2025/26.
A couple of important points here. It’s turnover, not profit. Every pound you invoice for taxable goods or services counts – before you deduct expenses, wages, or anything else. And it’s measured on a rolling 12-month basis, not a fixed tax year. So, you need to be checking at the end of every month whether your previous 12 months of invoicing have crept past that £90,000 line.
This catches people out more than you’d think. Business is ticking along nicely, you land a couple of good contracts, and suddenly you’ve drifted over the threshold without realising. HMRC won’t send you a friendly heads-up. It’s on you to monitor it.
There’s also a forward-looking test. If you know – right now – that you’re going to exceed £90,000 in the next 30 days alone (maybe you’ve just signed a big contract), you need to register immediately. Not at the end of the month. Now.
Once you breach the threshold, you have 30 days to notify HMRC. Miss that window and you could face penalties, plus you’ll owe VAT backdated to when you should have registered. Not a great start.
On the flip side, if your turnover drops below £88,000, you can apply to deregister. That small buffer between £90,000 and £88,000 is deliberate – it stops businesses from constantly hopping in and out of the system every time their turnover wobbles around the threshold.
The bit nobody tells you: that 20% was never yours
Here’s where we need to have an honest conversation.
When you become VAT-registered and start adding 20% to your invoices, it can feel like you’ve just given yourself a pay rise. Your £1,000 invoice is now £1,200. There’s more money landing in your bank account. Happy days, right?
Wrong. That extra £200 was never your money. Not for a second. You’re collecting it on behalf of HMRC, holding it temporarily, and handing it over when your quarterly VAT return is due.
You are, in the most literal sense, an unpaid tax collector for the government.
This is the single most important thing to get your head around when you register for VAT. The business’s revenue is still £1,000. The £200 is a liability sitting in your bank account, waiting to be paid to HMRC. It just happens to be sitting alongside your actual money, which is where the trouble starts.
We see it all the time. A new business owner registers for VAT, starts collecting the 20%, and – because it’s all in the same bank account – gradually starts spending it. On a new laptop, on pension contributions, on that new apple watch. Then the quarterly VAT bill lands, and if you have not planned for it there’s a scramble to find the cash.
The fix is simple: ring-fence your VAT from day one. Open a separate bank account, and every time a payment comes in, sweep the VAT portion straight across. Treat that account as untouchable. It’s not your money and it never was. Do this, and VAT will never cause you a cash flow headache.
Alternatively, use accounting software like Joy Pilot, and keep it up to date. Not only can you quickly see how much VAT you owe, you can also see how much of that money in your business bank account is actually yours to spend.
“But won’t my clients be upset about a 20% price hike?”
This is the other big worry we hear, and for most of our clients, it’s a non-issue.
Here’s why. If your client is VAT-registered – and if you’re a contractor, consultant, or freelancer supplying services to other businesses in the UK, they almost certainly are – then the VAT you charge them is fully reclaimable. They claim it back from HMRC as input tax. The net cost to them is exactly the same as it was before you registered.
Let’s say you’ve been invoicing a client £5,000 a month. You register for VAT, and your invoice now shows £5,000 plus £1,000 VAT – total £6,000. Your client pays £6,000, then reclaims that £1,000 on their own VAT return. Their actual cost? Still £5,000. They genuinely don’t care.
In fact, in many B2B sectors – IT, consultancy, professional services, contracting – being VAT-registered is seen as a sign of professional credibility. It signals that you’ve reached a certain scale, that you’re operating within the standard business framework.
Where it does matter is if you’re selling to consumers – individuals who can’t reclaim VAT. A personal trainer, a hairdresser, a tradesperson working for homeowners. In those situations, VAT really does represent a 20% price increase that your customer has to absorb. That’s a genuine competitive consideration.
But for the vast majority of contractors and consultants supplying services to other businesses? It’s a non-event.
Choosing your VAT scheme: Standard, Cash, or Flat Rate?
Once you’re registered, you need to decide how you’re going to account for VAT. HMRC offers a few different schemes, and the right one depends on your business type, your expenses, and how your clients pay.
Cash Accounting Scheme
For most contractors and freelancers, cash accounting is the natural starting point. Available to businesses with taxable turnover up to £1.35 million, the cash accounting scheme means you only pay VAT to HMRC when your client actually pays you, and you reclaim VAT on your expenses when you actually pay your suppliers.
This is how most people intuitively expect VAT to work, and it’s what most accountants will set you up with from day one. The cash flow protection is the big draw. You’re never handing money to HMRC before it’s hit your bank account. And if a client never pays at all, you never owe the VAT on that invoice. That’s automatic bad debt relief, built right in.
Standard (Invoice/Accrual) Accounting
The alternative is standard accounting, sometimes called invoice or accrual accounting. Here, you account for VAT based on invoice dates – output tax when you issue an invoice, input tax when you receive one from a supplier – regardless of when the money actually changes hands.
Why would anyone choose this over cash accounting? A few reasons. If your business has grown beyond the £1.35 million cash accounting threshold, standard is your only option. It also lets you reclaim input VAT as soon as you receive a supplier invoice, even if you haven’t paid it yet — which can be useful for businesses with significant credit-based purchasing or heavy capital expenditure where you want those VAT reclaims flowing through quickly.
But for most small businesses starting out, they take the Cash Accounting option.
Flat Rate Scheme (FRS)
The flat rate scheme was designed to simplify things for small businesses with low overheads. Available if your turnover is £150,000 or less (excluding VAT), the idea is simple: you still charge your clients 20% VAT, but you pay HMRC a lower, fixed percentage of your gross turnover. The percentage depends on your industry – IT consultants pay 14.5%, management consultants 14.0%, and so on. You keep the difference.
On paper, it sounds great. An IT contractor billing £1,000 plus VAT receives £1,200, pays HMRC 14.5% of that (£174), and pockets the remaining £26. There’s also a 1% discount in your first year of registration, which sweetens the deal further.
But here’s the catch – and it’s a big one. If your spending on “relevant goods” is less than 2% of your turnover (or less than £1,000 a year), you’re classified as a “limited cost trader” and you’re bumped up to a flat rate of 16.5%. And the definition of “relevant goods” is painfully narrow. Software subscriptions, rent, accountancy fees, phone bills – none of these count. Only tangible, physical goods like stationery or stock qualify.
For most service-based businesses – which is most of our clients – you’ll almost inevitably land on 16.5%. At that rate, you’re often paying more than you would under standard accounting, and you’ve lost the ability to reclaim VAT on your expenses. The scheme that was supposed to simplify things has actually cost you money.
The flat rate scheme can still work well for businesses that genuinely buy a decent amount of physical goods – certain retailers, caterers, or tradespeople. But for contractors and consultants, it’s worth running the numbers very carefully before committing.
“…the service has been fabulous.”
Ah Mike, we think you’re pretty fabulous too!
A few more things worth knowing
You can reclaim VAT on stuff you bought before you registered. This is a nice one that a lot of people miss. HMRC lets you look back and reclaim VAT on goods you purchased up to four years before registration, provided they’re still in use on your registration date. For services, the look-back period is six months. So that laptop you bought two years ago, or the accountancy fees you paid last quarter – you may well be able to claim the VAT back on your first return.
Making Tax Digital is non-negotiable. Every VAT-registered business must keep digital records and file returns through MTD-compatible software. This has been mandatory since April 2022. If you’re already using cloud accounting software like Joy Pilot you’re already covered. If you’re still working off spreadsheets or shoeboxes of receipts, registration is your cue to get that sorted.
Late filing and late payment penalties are real. HMRC operates a points-based system for late returns – miss enough deadlines and you’ll start getting £200 fines for every subsequent late submission. Late payments attract penalties from day 16 and interest from day one. The days of getting away with a casual approach to VAT deadlines are well and truly over.
The bottom line
VAT registration isn’t something to fear. Yes, it comes with admin. Yes, you need to stay on top of your returns and your cash flow. But for most contractors and small business owners supplying services to other VAT-registered businesses, it changes remarkably little in practice.
Your clients won’t care. Your prices haven’t really gone up. And with the right scheme, the right software, and a separate bank account for the VAT you collect, the whole thing can run pretty smoothly in the background while you focus on what actually matters – running your business.
If all of this feels like a lot to keep track of, that’s because it is – but it doesn’t have to be your problem. At No Worries Accounting, we monitor your turnover against the VAT threshold as part of our ongoing service, so you’ll never be caught off guard by a registration deadline you didn’t see coming. When the time comes, we handle the registration process with HMRC, get you set up on the right scheme for your business, and from there we prepare and file your VAT returns every quarter. You focus on the work. We’ll make sure the VAT takes care of itself.