VAT

While VAT creates additional paperwork, it can also reduce your costs by allowing you to reclaim the VAT you pay on your business purchases. Many businesses have no choice but to register for VAT once their sales reach £85,000 a year.

You need to understand whether you can or should register for VAT, and what you must do as a VAT-registered business, especially if you fall within the requirements of the HMRC Making Tax Digital initiative. You may be able to simplify your VAT requirements by using an appropriate VAT accounting scheme.

1. How VAT works

VAT is a tax on business transactions that potentially affects all purchases and sales. It is not a tax on profits. VAT is currently charged at 20% on most supplies, though some are taxed at either 0% or 5%, or exempt (see ‘What is VAT charged on?’).

All businesses pay VAT on their VATable purchases

• Any VAT you pay is called ‘input VAT’.
• VAT-registered businesses can usually reclaim the input VAT they pay from HMRC.

VAT-registered businesses charge VAT on their VATable sales

• Businesses that make significant VATable sales are required to register.
• The VAT you charge is called ‘output VAT’.

VAT-registered businesses are collecting VAT on behalf of HMRC

• The difference between the output VAT you charge and the input VAT you can reclaim is handed over to HMRC, usually quarterly.
• For example, a VAT-registered shop selling a £30 vase will add £6 (20%) VAT, making the total price £36. The shop might have bought the vase from its VAT-registered supplier for £12 (ie £10 plus £2 VAT). So the shop owes HMRC £4 (ie £6 output VAT less £2 input VAT).

2. What is VAT charged on?

For VAT purposes, goods and services are divided into four categories.

Standard-rated supplies

• A large proportion of goods and services are standard-rated.
• VAT is charged at 20%.

Reduced-rated supplies

• These include domestic fuel, residential conversions and some refurbishments, installing energy-saving materials in residential accommodation, and children’s car seats.
• VAT is charged at 5%.
• Even though VAT is charged at 5%, all associated VAT paid on business purchases, regardless of the rate paid, should be reclaimable.

Zero-rated supplies

• These include most food, children’s clothing, construction of new houses, books, printed matter and prescription drugs.
• VAT is charged at 0%.
• Exports to customers outside the EU and to VAT-registered customers within the EU can also normally be zero-rated. Special rules and procedures apply.
• Even though no VAT is charged on zero-rated supplies, a business can still register for VAT and reclaim the input VAT paid on associated purchases.

Exempt supplies

• These include finance, insurance and many property transactions.
• VAT does not apply to exempt supplies. Unlike standard-rated, reduced-rated and zero-rated supplies, they are not VATable. Businesses that only sell exempt supplies cannot register for VAT.
• No VAT is charged on exempt supplies, and input VAT paid on associated business purchases cannot be reclaimed.