VAT basics explained
What is VAT?
VAT - or value-added tax - is a tax levied on sales of goods and services. Think of it as a tax or fee you add to goods and services, depending upon their value.
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 other business.
- You charge VAT on the items or services you sell to other businesses and customers/clients.
- 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 £85,000 (the 'VAT threshold' - accurate as of 2018)
- You think your turnover will soon be more than £85,000 (accurate as of 2018)
For some small businesses, it can be beneficial to register even if your turnover is less than £83,000 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 that 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 is VAT?
- There are three different rates:
- Standard rate: 20%
- Reduced rate: 5 %
- Zero rate: 0%
- Most items are standard rate unless they specifically say otherwise.
- The 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 (bar 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 here.
How you work out VAT:
- You have to charge VAT on every sale you make to other businesses or customers - in other words, you have to add it to the price.
- 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 the total.
- 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 the VAT you've charged on sales and the VAT you've been charged on purchases. Find out more in this guide on how to keep VAT records.
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 months.
- 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 online.
- 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 online.
- 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 cash flow management easier.
- 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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