Reporting and paying value-added tax, commonly called VAT, is a quarterly issue for small businesses all across the UK. Sometimes, managing to pay a VAT bill on time to HM Revenue & Customs (HMRC) can be difficult, leaving business owners to face late payment penalties that would leave anyone feeling queasy.
That’s why so many businesses use VAT loans as a method of short-term financing that can plug the gap. But how do they work, how do you apply and what should borrowers look for when shopping for a loan?
Well, you can’t understand VAT loans without understanding VAT, so we are kicking things off with a simple explanation.
What is VAT?
VAT is a sales tax of 20% that applies to most goods and services sold by businesses over a certain size.
Some goods and services are fully exempt, such as sporting activities, while others might see VAT charged at a reduced rate, such as nicotine gum, or at a zero rate, including many types of food and drink. Exempt goods and services do not come with any VAT, but pertinent information must still be recorded in the seller’s VAT return.
A zero rating means the current rate is 0% tax, but that the government could charge VAT down the line.
From 1 April 2024, every business with a VAT taxable turnover of £90,000 or above from the last 12 months must register to pay VAT. This increased in the 2024 Spring Budget from £85,000.
Once you are a VAT-registered business, you have responsibilities like including VAT in the pricing of your goods and services, or keeping track of how much your business pays in VAT on goods it purchases.
This is called a VAT return, and most businesses must complete one every 3 months.
Depending on the contents of your return, you may have to pay HMRC or be reimbursed by HMRC. This will depend on whether you have charged more VAT than you have paid. If you have charged more than you have paid, you must pay the difference to HMRC.
That’s where VAT loans come into the picture.
» MORE: Business tax in the UK
How do VAT loans work?
VAT loans are aimed at businesses who will struggle to pay their VAT bill on time. They are a short-term solution for companies with a cash-flow problem that makes dealing with mandatory VAT bills challenging.
For businesses that fail to pay VAT on time, HMRC applies late payment interest from the date the deadline is missed. In addition, first and second late payment penalties incurred 16 and 31 days after missed deadlines can lead to late VAT payments spiralling out of control.
As such, finding a short-term solution is a preferable option for many small businesses drawing close to their payment deadline. It’s important to note that loans should be taken out before missing any of these deadlines, as lenders can be reluctant to cover late payments.
It is also key to consider that VAT loans are generally secured loans, meaning your assets will act as collateral to ensure repayment. You may also have to provide a personal guarantee to secure a VAT loan.
Additionally, VAT loans are generally short-term loans, with typical repayment periods of between 3-12 months.
How much can you borrow with a VAT loan?
While VAT loans are normally for far smaller amounts, businesses can borrow as much as £5 million with this type of financing. Of course, the amount a business borrows will depend upon its VAT return and a lender’s assessment of its capability to repay the loan.
What is the interest rate on a VAT loan?
Interest rates on VAT loans will vary greatly depending on factors such as a borrower’s credit score and the current market rate. Some providers advertise rates of less than 1%, but interest rates have historically been more than 4%.
Short-term loans such as VAT loans often carry higher interest rates than other types of loans, as this improves lenders’ ability to make money on loans which are repaid across just a few weeks or months.
Additionally, short-term loans can also come with additional fees that make them more costly for borrowers.
What is a VAT bridging loan?
A VAT loan is not to be confused with VAT bridging loans. Although the two forms of borrowing sound the same, there are some important differences.
Rather than referring to quarterly VAT returns owed to HMRC, VAT bridging loans are used to help businesses pay for the VAT charge of 20% on certain property purchases. Generally, VAT is only charged on purchases of new commercial properties.
As such, you can ignore VAT bridging loans if you are searching for help with the costs of quarterly VAT returns.
How to choose a VAT loan
Several key factors should contribute to your decision on which VAT loan to apply for:
- Lending amounts: Different lenders allow businesses to borrow different amounts of money. Find one that fits your needs.
- Interest rates: Interest rates will vary between different lenders. Remember that the headline interest rate advertised by a lender may not match the rate your business is offered.
- Additional fees: Arrangement fees or early repayment fees might be charged by some lenders, so make sure you understand exactly what you are paying for before picking a loan.
- Repayment terms: Some lenders require you to repay a loan within three months, while others might offer longer terms.
- Requirements: Your business might be required to have been trading for a certain amount of time or have achieved a certain level of success to be eligible for a VAT loan. You may also need to provide collateral to secure the loan or fill out a personal guarantee. Make sure your business meets any requirements and that you are happy with any risk to your assets posed by the loan.
- Approval rates: High approval or acceptance rates are advertised by some lenders. If your application is time-sensitive, you may want to consider a lender with a high approval rate to avoid wasting time with an application that ultimately fails.
- Turnaround times: If you are nearing a VAT payment deadline you might want to choose a lender that offers speedy credit decisions and quick access to funds.
How to apply for a VAT loan
The first issue with applying for a VAT loan is timing your application, as you should make sure to apply before missing VAT payments. That’s because many lenders will not offer a loan to cover a payment that is already overdue.
When you have chosen a provider using the previously listed factors, you need to get down to the business of applying for a loan. Different lenders have different requirements, but you will likely need to prepare several documents to prove your business’s eligibility. Documents and information you will need to hand might include:
- Business bank statements and accounts: These documents can be used to establish turnover and whether you can afford to repay the loan you have applied for.
- ID documents: Lenders may require proof of identity for you and any other directors of the business. They may use these to carry out personal credit checks.
- Company information: Your company name, address and registration number allow lenders to check the business’s legitimacy and view public domain financial information from Companies House.
When do small businesses apply for a VAT loan?
Several circumstances might lead to a business needing to seek short-term lending such as a VAT loan. These include:
- unexpected costs, such as repairs to important equipment
- large purchases or similar reinvestment into your business
- seasonal fluctuations in revenue
- cash-flow issues, such as money being tied up in illiquid assets
To find out how to better manage working capital, read NerdWallet’s guide to working capital.
Other business funding options
A VAT loan may not be the right option for your business. It is key to remember the other available funding options for businesses. Consider business loans, government grants, rolling credit facilities, asset financing and angel investors.
There are positives and negatives associated with each source of funding, so make a careful decision based on what is best for your business. You may even choose to combine multiple financing methods to give your business the boost it needs.
» COMPARE: Business loans with NerdWallet
How can I compare business loans?
Comparison sites such as NerdWallet give you the tools to look at how different lenders stack up side by side.
These comparison sites feature pages like our business loan tables which give information about lenders’ specific terms and headline interest rates. These rates offer an indication of how different lenders compare, but your exact rate may differ based on the unique characteristics of your business.
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