What is VAT? - Complete guide to Value Added Tax

3 August 2022 Brian Gooch View all News

Most people will have heard of VAT. What people might not realise is that a third of all revenue collected by the government comes from VAT.

So, in fact, it not only affects businesses, but every one of us on a day-to-day basis, in many purchases that we make (both online and on our high street).

Despite its importance, VAT remains one of the least understood of all taxes.

To the high street consumer, VAT becomes part of the cost of the purchase price, and we often do not even think about it. Businesses, however, have a different outlook on VAT. To business, VAT is often profit neutral but nevertheless an important area of their activities, and failure to account for it in the correct manner can lead to serious issues.

This guide is, therefore, aimed more towards businesses than the general consumer.

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VAT errors come in all shapes and sizes but can generally be rectified on the next VAT return you submit. You can learn more about this free service below.

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What is VAT?

VAT is an acronym for Value Added Tax and was introduced in the UK in 1973. It is a tax that is applied to the purchase price of certain goods, services and other taxable supplies that are bought and sold within the UK. It is consistent with, but now distinct from, the system of VAT that operates within the European Union.

What is the VAT rate?

There are 3 rates of VAT chargeable in the UK and each rate depends on the goods or services being provided. The table below sets out these rates and what they generally apply to.

 

Rate

Charge

Applied to

Standard

20%

Most goods and services

Reduced

5%

Some goods and services such as home energy, children’s car seats, residential property conversions, etc.

Zero

0%

Most foods and children’s clothing

 

VAT does not, however, apply to all sales and some are either exempt from or outside the scope of VAT. For example, insurance, health care, postage stamps and education are exempt, whereas statutory fees, goods or services bought and used outside the UK and donations to charities are outside the scope of UK VAT.

What is the VAT threshold?

You must register for VAT if your taxable turnover exceeds £85,000. Taxable turnover is defined as all turnover generated by sales that are not VAT exempt. Even turnover on which the VAT rate is zero is classed as taxable turnover.

Companies who do not pass this threshold do not need to charge VAT on the sale of their goods or services and do not need to register with HM Revenue & Customs (HMRC).

If a business has turnover of above the threshold then they must contact HMRC and register for VAT.

This turnover threshold is measured in a rolling 12-month period rather than a fixed period like the tax year or the calendar year. Therefore, it could be any period of 12 whole months, for example, the start of June until the end of May.

It is important for un-registered businesses whose turnover is close to the registration limit to keep a regular close eye on this, as there are strict deadlines for submitting the registration and charging VAT once the turnover threshold has been passed.

Registering for VAT

VAT applies similarly to any business structure in this context, including companies, partnerships, and sole traders. 

Upon registration, HMRC will issue a VAT registration certificate confirming the business’ VAT number, effective date of registration and the due date of the first VAT return. 

It should be noted that any business with a turnover below the threshold can choose to register for VAT, this is known as voluntary registration. There can be advantages of voluntarily registering for VAT, such as the ability to reclaim VAT on purchases and creating a more trustworthy and professional image to customers.

Accounting for VAT

Once registered, a business will need to include the relevant rate of VAT on all their taxable sales. This is referred to as output tax. The VAT is ultimately paid by their customers, but it is the business’ responsibility to report and pay this to HMRC.

Businesses can also usually reclaim VAT paid on business related purchases, which is known as input tax. However, some items are not eligible for VAT reclaims, such as entertaining costs, cars and (for unincorporated businesses) purchases used for private use.

How to calculate VAT

Calculating VAT is quite straightforward. To find VAT-inclusive prices, you can simply multiply the price excl. VAT by 1.2, thereby adding the standard 20% rate of VAT to the price. For the 5% reduced rate of VAT, simply multiply the price (excl. VAT) by 1.05.

If you wish to calculate VAT-exclusive prices, simply divide the total price (including VAT) by 1.2 for the standard (20%) rate, or by 1.05 for the reduced (5%) rate.

What is a VAT return?

VAT registered businesses must report the amount of output tax and input tax to HMRC via the submission of a VAT Return. This is usually completed every quarter. Most VAT registered businesses that have a turnover in excess of £85,000 must also follow the rules for Making Tax Digital (MTD) for VAT, which were introduced in April 2019. 

What is my VAT number?

A VAT Number, also known as VAT Registration Number, is a unique code that is issued to a company that is VAT registered. This number is 9 digits long and will usually feature GB at the start. HMRC will issue a company a VAT registration certificate on which the company can find their VAT number.

It is very important that your VAT number is checked whenever submitting VAT returns. Mistakes in your VAT return can cause delays, while HMRC may disallow your tax input claim.

How to check if a company is VAT registered

You can check whether a UK company is VAT registered using a service on the UK Government website. This service lets you check if a VAT Registration number is valid and will also allow you to look up the business name and address that the number is registered to. It can also be used to keep a record of when you have checked a UK VAT number.

VAT Penalties

vat-penalty

VAT registration is a legal obligation, failure to adhere to these rules can lead to substantial penalties and in the worst cases a custodial sentence. 

The penalty levied by HMRC for late registration is worked out as a percentage of the VAT due (output tax less input tax), from the date when a business should have registered to the date when either HMRC receive your notification, or became fully aware that you were required to be registered.  The rate of penalty depends on how late you were in registering:

 

If registered

Penalty rate

Not more than 9 months late

5%

More than 9 months but not more than 18 months late

10%

more than 18 months late

15%

 

HMRC can also charge surcharges if they do not receive the VAT return or full payment for the VAT due by the deadline.  These surcharges can be up to 15% of the VAT outstanding at the due date.  They also have the power to levy penalties of up to 100% of any tax under-stated or over-claimed if a business sends a return that contains a careless or deliberate inaccuracy.

The above is aimed to be a quick introduction to VAT, but the reality is that the scope is far wider and can be extremely complicated.  We haven't even touched here, on the areas of partial exemption or the VAT margin schemes.   HMRC take VAT compliance seriously so it is essential that businesses account for VAT correctly.  Specialist advice is, therefore, highly recommended.

How to claim VAT back?

You may be able to reclaim VAT on goods and services that are used exclusively by your business, such as computers, office furniture, transportation, and third-party vendor costs (such as accountants).

You cannot reclaim VAT on goods and services intended for personal use, nor can you claim back VAT on business entertainment costs.

Reclaiming VAT requires completion of a quarterly VAT Return. This requires you to calculate the difference between the amount of VAT your business paid, and how much VAT the business charged, during an accounting period.

The process of reclaiming VAT is not simple, and there are many exceptions, exemptions and caveats that must be considered. Therefore, we strongly recommend discussing your requirements with a qualified business taxes expert.

What items are not subject to VAT?

vat-exempt-shopping

Many goods and services are exempt from VAT; however, there are often particular items within a goods or services category for which VAT is chargeable.

For example, food and drink is generally zero-rated for VAT; however, exceptions to this include hot food, crisps, alcoholic drinks, confectionery and soft drinks. Many of these exceptions have exceptions of their own!

There are far too many specific items to list here, but for a more in-depth look at which items are exempt from VAT or zero-rated, we suggest consulting a VAT specialist.

Do charities pay VAT?

Any business that makes sales that exceed the UK VAT threshold must register for VAT, this can include charities and their trading subsidiaries. VAT registered charities must charge VAT on any standard or reduced rated goods and services sold.

Charities may be able to claim VAT relief on certain goods and services; they may also be able to reclaim some of that VAT from HMRC. It is recommended that charities consult a tax expert to determine whether they qualify for either of these.

What about properties and VAT?

Property related transactions can cover the full gamut of VAT possibilities – exempt, zero-rated, reduced-rated or standard rated.

Different rules can apply to purchases and sales, residential, commercial, or charitable buildings, construction, renovation and conversion. In some cases with commercial property there is a little flexibility, but it is important to decide on the correct approach at the outset because there are also potential pitfalls.

Property transactions tend to be high value, therefore getting the VAT treatment wrong can be expensive.

Different areas of VAT

VAT is complex and covers many areas of operation within a business - each of these includes specific (often complicated) considerations that businesses must make in order to avoid issues.

How to get VAT advice

VAT remains one of the least understood of all taxes, which is why we set up a specialist VAT advisory department, to help guide businesses through the complex maze of VAT legislation.

Our team helps with all areas of VAT from relatively basic issues, such as initial registration, the completion and submission of VAT returns, and advice on how to correct errors and mistakes, through to more complex issues such as assessments, control visits, cross border transactions and DIY house builds.

Whatever your VAT query; why not get in touch, and discuss any queries you may have with a member of our team.

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