Pictured above: Jason Croke

The standard rate of VAT will rise to 20 per cent from January 4, 2011. Jason Croke, regional VAT consultant at chartered accountants Haines Watts, discusses the effect this change could have on businesses and their end users.

In theory, trade between two VAT registered businesses, or b2b, is generally VAT neutral. An increase in the VAT rate will see a marginal decrease in cash flow for the supplier as they have to pay over more VAT to HMRC whilst awaiting their business customer to pay the invoice. This may be more pronounced should business customers demand, as they are currently doing, ever longer payment periods beyond the traditional 30 days.

Depending upon turnover, there are VAT schemes which can assist cash flow, especially with customers with long payment terms. It is possible for any business to change the way invoices are both issued and processed which can help minimise the impact of VAT rate change on cash flow.

Trade between businesses which are not VAT registered or are VAT registered but cannot reclaim all the VAT charged to them are a different matter. The increase in price will affect them and their bottom line budgets. So businesses who trade with the not-for-profit sector or financial services/insurance will find their customers negotiating much harder come renewal of contracts. As indeed, will businesses that operate within business-to-consumer sectors.

VAT is a tax on the end user, which usually means the general public. If your core business is to consumers then the VAT increase will have a more pronounced effect.

The initial response may be to lower prices and absorb some or all of the VAT increase, especially if you operate within a very competitive market sector. If you have less competition or if price is not the deciding factor for your customer, then it may make more sense to raise your prices to reflect the additional VAT cost.

Be careful of trying to maintain a pre-increase price point.  An item sold for £10 before January 2011 would be subject to £1.48 in tax with the businesses keeping £8.52. The new VAT rate will mean that a product costing £10 in January will be subject to £1.67 tax with the business keeping £8.33 - a drop in margin of 19p.  Your accountant can help with overall cash flow and margin projections to help determine whether to freeze or increase prices in your business.

Those businesses which are not VAT registered may see an initial increase in sales as consumers seek out cheaper alternatives, especially in very competitive markets. However, any potential increase in customers and turnover may lead to that 'small' business exceeding the VAT registration threshold and so there may be more businesses on a level, VAT registered playing field as a result.

Certainly, the VAT increase will mean that prices are likely to go up.  How much this increase will be depends on your margins, the competition and the market place for your products/services. Retailers and web based sellers will have to update their prices on the shelf/web as well as reprogramming tills, accounting software and labelling where appropriate.  All of these involve additional time and therefore cost burdens to the business.

There may be an increase in avoidance, for example, through artificial separation of trades to keep below the VAT registration threshold or perhaps from customers or suppliers insisting on more 'cash' jobs which will further increase pressure to maintain customers and competitive advantage.

For more information on Haines Watts, please visit their website here: www.hwca.com