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What is VAT?
VAT is a tax that's charged on most business transactions in the UK. Businesses add VAT to the price they charge when they provide goods and services to:
- Business customers - for example a clothing manufacturer adds VAT to the prices they charge a clothes shop
- Non-business customers - members of the public or 'consumers' - for example a hairdressing salon includes VAT in the prices they charge members of the public
If you're a VAT-registered business, in most cases you:
- Charge VAT on the goods and services you provide
- Reclaim the VAT you pay when you buy goods and services for your business
If you're not a VAT-registered business or organisation then you can't reclaim the VAT you pay when you purchase goods and services.
Who charges VAT and what VAT is charged on
VAT-registered businesses add VAT to the sale price of most goods and services they provide.
When you must register for VAT
If you're a business and the goods or services you provide count as what's known as 'taxable supplies' (see 'What is VAT charged on' below) you'll have to register for VAT if either:
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Your turnover for the previous 12 months has gone over a specific limit - called the 'VAT threshold' (currently £68,000)
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 fill in a VAT Return at regular intervals - usually quarterly - and send it to HM Revenue & Customs (HMRC). The return shows:
The VAT you've charged on your sales to your customers in the period - known as output tax
The VAT you've 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 a VAT repayment on your return.
There are special schemes that some businesses can use to help them work out and pay their VAT.
Rates of VAT
There are different VAT rates, depending on the goods or services that are being provided. At the moment there are three rates:
Standard rate - 17.5% to be raised to 20% Jan 2011
Reduced rate - 5 per cent
Zero rate - 0 per cent
The standard rate of VAT is the default rate - this is the rate that's charged on most goods and services in the UK unless they're specifically identified as being reduced or zero-rated.
Examples of reduced-rated items
These are some examples of goods and services that may be reduced-rated, depending on the product itself and the circumstances of the sale:
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Domestic fuel and power
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Installing energy-saving materials
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Sanitary hygiene products
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Children's car seats
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This isn't a complete list of reduced-rated items and services.
Examples of zero-rated items
These are examples of goods and services that may be zero-rated, depending on the product itself and the circumstances of the sale:
Food - but not meals in restaurants or hot takeaways
Books and newspapers
Children's clothes and shoes
Public transport
This isn't a full list of zero-rated items.
Items not covered by VAT
There are some items that aren't covered by VAT. These items are either:
exempt
outside the scope of VAT
Exempt items
Some items are exempt from VAT because the law says they mustn't have any VAT charged on them. Items that are exempt include the following:
Insurance
Providing credit
Education and training, if certain conditions are met
Fundraising events by charities, if certain conditions are met
Membership subscriptions
Most services provided by doctors and dentists
Selling, leasing and letting commercial land and buildings are also exempt from VAT. But you can choose - or 'opt' - 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 (see 'The difference between exempt and zero-rated' below).
Read about VAT exemptions for education in VAT Notice 701/30 on the HMRC website
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. They are not taxable supplies and no VAT is charged on them. Items that are outside the scope of VAT 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
The difference between exempt and zero-rated
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.
If you sell goods or services that are exempt, you don't charge any VAT and they're not taxable supplies. This means that you won't normally be able to reclaim any of the VAT on your expenses.
Generally you can't register for VAT or reclaim the VAT on your purchases if you sell only exempt goods or services. If you sell some exempt goods or services you may not be able to reclaim the VAT on all of your purchases.
If you buy and sell only - or mainly - zero-rated goods or services you can apply to HMRC to be exempt from registering for VAT. This could make sense if you pay little or no VAT on your purchases.
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