1. VAT overview
VAT (Value Added Tax) is a tax on sales that's charged on most goods and services provided by VAT-registered businesses in the UK, of any structure, including limited companies, partnerships and sole traders.
VAT is charged when a VAT-registered business sells goods or services to a customer - whether the customer is a business or an individual. When a VAT-registered business buys goods or services they can generally reclaim most of the VAT they have paid.
Disclaimer
This article is a general introduction to help small businesses (including sole traders) be aware when they may need to become VAT registered. The information may be subject to change and may not apply to your business or circumstances. As a business owner, you are responsible for ensuring you register for VAT when required and should obtain independent, expert advice.
2. Charging VAT
VAT-registered businesses add VAT to the sale price of most goods and services they provide.
When you must register for VAT
You may have to register for VAT if either:
- your turnover for the previous 12 months has gone over a specific limit - called the 'VAT threshold' (currently £90,000)
- you think your turnover will soon go over this limit
You can choose to register for VAT if you want, even if you don't have to.
What is VAT charged on?
If you're VAT-registered, you'll have to charge VAT on any goods and services that you provide in the UK that are VAT taxable. You charge VAT on the full sale price, even if you accept goods in part exchange or through barter instead of money.
How VAT is charged and accounted for
If you're VAT-registered, the VAT you add to the sale price of your goods or services is called your 'output tax'. The VAT you pay when you buy goods and services for your business is called your 'input tax'.
Filling in your VAT Return
If you're VAT-registered, you'll have to submit a VAT Return at regular intervals - usually quarterly - and send it to HM Revenue & Customs (HMRC). The return shows:
- the VAT you have charged on your sales to your customers in the period - known as output tax
- the VAT you have paid on your purchases - known as input tax
If the amount of output tax is more than the input tax, then you send the difference to HMRC with your return.
If the input tax is more than your output tax, you claim the difference back from HMRC.
3. When you must register for VAT
No matter your business structure - whether a limited company, partnership or sole trader - you must register for VAT if either:
your VAT taxable turnover for the previous 12 months has gone over a specific limit - called the 'VAT threshold' (currently £90,000)
you think your VAT taxable turnover will soon go over this limit (within the next 30 days)
Note, in this situation, the previous 12 months is the previous rolling 12 months - not the previous calendar year or financial year. If you are close to the threshold, you will need to monitor this monthly.
You must register within 30 days of reaching this limit or risk penalties.
4. VAT rates
There are different VAT rates, depending on the goods or services that are being provided. Currently there are three rates:
- standard rate - 20 per cent
- reduced rate - 5 per cent
- zero rate - 0 per cent
Reduced-rated items
Goods and services that may be reduced-rated include:
- domestic fuel and power
- installing energy-saving materials
- sanitary hygiene products
- children's car seats
Zero-rated items
If you sell zero-rated goods or services, they count as taxable supplies, but you don't add any VAT to your selling price because the VAT rate is 0 per cent.
Goods and services that may be zero-rated include:
- food - but not meals in restaurants or hot takeaways
- books and newspapers
- children's clothes and shoes
- public transport
Exempt items
Some items are exempt from VAT, including:
- insurance
- providing credit
- education and training, if certain conditions are met
- fundraising events by charities, if certain conditions are met
- membership subscriptions, if certain conditions are met
- most services provided by doctors and dentists
Selling, leasing and letting of commercial land and buildings are also exempt from VAT.
But you can choose to give up the right to the exemption and to charge VAT at the standard rate instead. This allows you to reclaim input tax when otherwise you wouldn't be able to.
Outside the scope of VAT
There are some things that aren't in the UK VAT system at all - they're outside the scope of VAT. These include:
- non-business activities like a hobby - for example, you might sell some stamps from your collection
- fees that are fixed by law - known as 'statutory fees' - for example the congestion charge or vehicle MOT tests
Read about Self Assessment: the basics.
5. What is VAT taxable turnover?
It's important to understand the difference between turnover and VAT taxable turnover, because you must register for VAT once your VAT taxable turnover reaches £90,000 in the previous rolling 12 months or will soon exceed this limit.
Business turnover is the total income over a given period, before any costs have been deducted.
The goods and services you sell to generate that turnover can be classed as:
exempt from VAT
out of scope of VAT
or VAT taxable
Exempt items
There are not many exempt items but they include income generated from:
insurance and financial services
education and training, if certain conditions are met
healthcare
charity events, if certain conditions are met
sports activities, if certain conditions are met
The proportion of exempt goods and services you sell affects your approach to VAT registration.
If all your goods and services are exempt items, it’s not just that you don’t need to register for VAT, you cannot register for VAT. This means you can’t reclaim any VAT on your business purchases or expenses.
If you are VAT-registered and incur VAT on any items that will be used to make exempt supplies, you are classed as partially exempt.
Selling, leasing and letting of commercial land and buildings are usually also exempt from VAT. But you can choose to give up the right to the exemption and to charge VAT at the standard rate instead. This allows you to reclaim input tax when otherwise you wouldn't be able to.
Out of scope items
There are some things that aren’t in the UK VAT system at all, so any income from these is out of scope of VAT, e.g:
statutory services where the fee is fixed by law e.g. MOT testing.
goods or services bought outside the UK and also sold outside the UK - section 4.8 in this UK Government VAT Guide explains various scenarios where the supply will be viewed as within or outside the UK and small businesses involved in transactions abroad may need professional advice to interpret this correctly for their circumstances.
VAT taxable items and VAT rates
VAT taxable items can be classed within one of three rates. The power to set VAT rates, and assign items to a specific rate is reserved to the UK Government.
Standard rate: currently 20% and covers the majority of goods and services.
Reduced rate: currently 5% which applies to - safety equipment like children’s car seats, domestic fuel, power and heating, and installing energy-saving materials.
Zero-rate: where VAT is 0% so is not charged at all and includes - most food (except restaurants, hot takeaways and confectionery), books, newspapers, children’s clothes and shoes, women’s sanitary products, and some goods and services for elderly or disabled people. You will also charge zero rate VAT on goods and services that you are exporting out of Great Britain, providing certain conditions are met. Find out more about VAT on exports.
It’s important when calculating your VAT taxable turnover not to confuse “zero-rate” items with “exempt items”. Even though you are not charging VAT on zero-rate items, they count toward your total VAT taxable turnover.
When selling your own zero rate goods and services, you will still be able to recover input tax, which is where you have bought goods and services and paid VAT for them. A tax professional will be able to assist you with calculating your VAT taxable turnover.
6. Voluntarily registering for VAT
You can choose to voluntarily register for VAT - even if you don't meet the threshold of £90,000 VAT taxable income. You can do this if some of your income comes from goods and services that are not VAT exempt.
Benefits
At first this might seem counterintuitive, however there are some benefits to registering before you are required to.
You may be financially better off if the nature of your purchases mean the VAT you have paid is greater than the amount you receive from sales, putting you in a VAT reclaim situation. In other words, your VATable sales are lower than your VATable costs. This situation is more likely to arise if your purchases are at the standard rate, but your sales are at reduced or zero rate.
Sometimes you can also claim the VAT on items you purchase before you registered for VAT.
You must register for VAT within one month of reaching the turnover threshold on a rolling year basis, which isn’t long when you’re juggling everything else in your business. Therefore If you’re hovering close to the threshold, and register early, you won’t need to monitor this quite so closely and reduce the risk of late registration penalties.
VAT registration gives the impression to customers that you are a serious business with growth ambition.
If you sell to VAT registered businesses, VAT registration will not impact the amount customers have to pay.
Considerations
The downside to becoming VAT registered if you don’t need to be, include:
Your individual customers and businesses who are not VAT registered will need to pay up to 20% more, if the goods and services you supply are not zero rated. For example if you are a gardener or a hairdresser, this may make you less competitive if other local businesses are smaller and do not charge VAT.
You will have more administration work submitting quarterly VAT returns.
7. Managing VAT
VAT-registered businesses add VAT to the sale price of most of the goods and services they provide.
What is VAT charged on?
If you're VAT-registered, you'll have to charge VAT on any goods and services that you provide in the UK which are subject to tax (known as "taxable supplies"). The majority of the goods and services sold in the UK are taxable supplies. You charge VAT on the full sale price, even if you accept goods in part exchange, or through barter instead of money.
How VAT is charged and accounted for
If you're VAT-registered, the price of all of your goods and services must be inclusive of VAT at the appropriate current VAT rate, which are summarised in section 3.
The VAT you add to the sale price of your goods or services is called your 'output tax'. The VAT you pay when you buy goods and services for your business is called your 'input tax'.
Filling in your VAT Return
You must keep accurate VAT records of your sales and business purchases. You will need to use accounting software to help you with this, but this is widely available and most of the frequently used software providers will support this.
When you're VAT-registered, you'll have to submit a VAT Return at regular intervals - usually quarterly - and send it to HM Revenue & Customs (HMRC). The return shows:
the VAT you have charged on your sales to your customers in the period - your output tax
the VAT you have paid on your purchases - your input tax
Paying or reclaiming VAT
If the input tax is more than your output tax, you claim the difference back from HMRC.
Professional advice
While it is very useful to do your own desk research to understand the basics and know what questions to ask, it is important you obtain professional tax advice if this is a new area for you.
Read more about other tax rates and allowances in our finance section.
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