VAT basics explained
What is VAT?
VAT - value added tax - is a tax levied on sales of goods and
services. Think of it as a tax on the value you add to
products and services - in other words, on the price
difference between what you've paid and what you charge for a
Not all businesses need to register for VAT. Find out more about
that below. If you are VAT-registered:
- You pay VAT on the items or services you buy from
- You charge VAT on the items or services you sell
to other businesses and customer s(if you are VAT registered).
- The idea is the VAT you pay and the VAT you charge roughly
equals out - if it doesn't, you level the balance with
HMRC. That's what your VAT return is for (see below).
When do you need to register for VAT?
- You must register if your turnover in the past 12 months
was more than £70,000 (the 'VAT threshold' - accurate as of
- You think your turnover will soon be more than £70,000
(accurate as of 2010)
For some small businesses, it can be beneficial to
register even if your turnover is less than £67,000 if:
- You buy many more items that charge VAT than you sell (as your
input tax will be much higher than your output tax, and HMRC will
reimburse you the difference. Find out more about how these
calculations work below).
- You think it your turnover will soon be over the threshold and
want to get the paperwork out of the way now.
- You want to seem more professional or assure customers you are
a legitimate business, certified by HMRC.
How much VAT is
- There are three different rates:
- Standard rate: 17.5% until 3 January 2011, 20%
from 4 January 2011 onwards.
- Reduced rate: 5 %
- Zero rate: 0%
- Most items are standard rate unless they specifically say
- Reduced rate applies to certain items such as
domestic fuel and power, installation of energy-saving materials,
sanitary hygiene products and children's car seats.
- Zero-rate applies to certain items such as food
(but restaurant meals or takeaways), books and newspapers,
children's clothing and shoes and public transport.
- Certain things are exempt from VAT, such as
insurance, providing credit, education, fund-raising events by
charities, membership subscriptions and most services provided by
doctors and dentists.
- Check with HMRC if you think your items or services may
be reduced or zero-rate or exempt. You can see a full list
of VAT ratings of items and services
How you work out VAT
- You have to charge VAT on every sale you make to
other business or customers - in other words, you have to add it to
- You do that by multiplying the cost by the VAT rate percentage,
then adding that to the cost of the item or service.
- You separate out VAT on receipts, showing the cost
(before VAT), the cost of VAT and what rate it was charged at, then
- Most businesses calculate VAT backwards from what they want the
total cost to be, to make the total cost a round number.
- You have to keep records of all VAT transactions.
That's VAT you've charged on sales and VAT you've been charged on
purchases. Find out more in this guide on how to keep VAT
How you pay VAT to HMRC
- You have to keep records of VAT on all purchases
and sales you make.
- The VAT you charge other businesses or customers
when they buy goods or services from you is called output tax.
- The VAT other businesses charge you when you buy goods or
services from them is called input tax.
- You usually fill out a VAT return every three
- This shows your net output tax and net input tax.
- You pay HMRC the net difference between your output tax
and input tax - in other words, the total VAT you've charged
customers minus the total VAT you've been charged for what your
business has bought.
- If your input tax is higher than your output tax,
in other words you've paid more VAT than you've received from
sales, HMRC will reimburse you.
- You can fill out a paper return or do it
- Your VAT payment is due on the same date as the due date
for your VAT return (unless you use the Annual Accounting
Scheme - see below). But if you pay online you have seven extra
calendar days in which to pay.
- If you fill out your return online you must also pay
- If you have a turnover of more than £100,000 or if you're newly
registered, you have to fill out your return and pay online.
The Annual Accounting Scheme
- If you use the Annual Accounting Scheme you only have to
fill out one return per year, at the end of the year.
- You pay VAT in nine instalments throughout the
year at monthly intervals, or three quarterly payments.
- You then make a balancing payment at the end of the year.
- It can reduce your paperwork and make cashflow management
- You can use it if your annual turnover is not expected to
be more than £1.35m.
Output tax: the VAT you charge other businesses or
customers when they buy goods or services from you
Input tax: the VAT other businesses charge you when
you buy goods or services from them
VAT: value added tax
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