A guide to VAT

emily coleman, tax, working for yourself


If your business is registered for VAT, then it must charge VAT on all the taxable sales it makes to all its customers.  It will also be able to reclaim some, but not all, of the VAT that its suppliers charge if it is registered for VAT.

But how does this work? Emily Coltman ACA, Chief Accountant to FreeAgent – which provides an online accounting system for small businesses and freelancers – explains in the second of a four-part series on VAT:

VAT that your business charges to its customers is called “output VAT”.

VAT that’s paid to suppliers, which can be reclaimed, is called “input VAT”. There are some supplies on which VAT can’t be reclaimed, and we’ll look at that in a moment.


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The VAT that your business will actually pay to HMRC each quarter is its output VAT less its input VAT.  If its input VAT for that quarter is greater than its output VAT, then HMRC will refund the difference to your business.

But what output VAT should you charge, and what input VAT can you reclaim?

What sales do you have to charge output VAT on?

When you’re VAT-registered, you have to charge output VAT to all your customers at the right rate for that sale. This applies whether or not your customer is VAT-registered.  You still have to charge them VAT if the sale is taxable.

There are three different rates of VAT operating in the UK: 20% (standard), 5% (reduced) and 0% (zero).  Zero-rated sales are still taxable and still subject to VAT, but the rate of VAT on them is 0%.

Most sales of goods and services in the UK are standard-rated.

The reduced rate applies most often to goods that are “quasi-essential” – that is, you could manage without them if you had to but it would be difficult.  These include, for example, children’s car safety seats – but not prams and pushchairs which are standard-rated!

Zero-rating applies to goods and services such as equipment for the blind and the disabled, passenger transport by bus, and books, magazines and newspapers – though e-books are standard-rated, and mobility aids for the elderly are reduced-rated.

As you can see, there are a lot of rules that determine the rating of a particular service or type of goods, down to the smallest detail.  For example, chocolate-covered shortbread is standard-rated, but add a layer of caramel between the biscuit and chocolate and turn it into millionaire’s shortbread, and it becomes zero-rated.

If you’re in any doubt have a look at http://www.hmrc.gov.uk/vat/forms-rates/rates/goods-services.htm which lists the more common types of goods and services that are reduced-rated or zero-rated.

You do need to know which rate applies to everything you buy or sell, before you enter it into your accounting system.  There is help at hand though – more on that at the end of this article.

Sales that you don’t charge output VAT on

But we haven’t finished yet.

There are some goods and services which are exempt from VAT.  That means no VAT is charged on them at all, which is different legally from zero-rated VAT where VAT is charged but at 0%.

The sale of insurance is exempt from VAT, as are sports activities.

And there are also some services and goods which are outside the scope of VAT altogether.  This includes, for example, MOT tests on cars.

Both exempt sales and out-of-scope sales are non-taxable sales.  So when you’re checking to see if you should register for VAT, don’t count these sales.

Input VAT

Whether or not you’re actually registered for VAT yourself, if you buy taxable goods and services from suppliers who are registered, you will pay VAT as part of what you pay to the supplier.

If your business is registered for VAT, as a rule of thumb you can then claim back this VAT – but not always.

There are some goods and services on which you’ll pay VAT to your suppliers but you can’t claim it back from HMRC.  Business entertaining is the classic example of this.  If you entertain anyone other than your own staff, HMRC say that the input tax on this is “blocked”, which means that you can’t reclaim it.

You also can’t reclaim input VAT if you don’t have a valid VAT invoice or valid simplified VAT invoice (such as a till receipt) from your supplier.

Also, if your business makes a lot of exempt sales, you may be restricted in the amount of input VAT you can claim.  If your business only makes exempt sales, you’re actually not allowed to register it for VAT.

If your business makes a mixture of exempt and taxable sales, then you can register, but you’ll only be able to reclaim the amount of input VAT that you incur on the taxable sales.  This is called partial exemption.

The calculations for this do get quite complicated because there will be some input VAT that relates to both types of sales, for example VAT on lawyers’ fees.

Even when you know when to charge output VAT and when to reclaim input VAT, there are still questions to ask about how you should add up your VAT return and what you’ll actually pay to HMRC.  We’ll look at that in the next VAT piece.

Where can I get help?

VAT can be very daunting but there is help available for business owners!

Using an accounting system like FreeAgent will set you on the right path because it has an “Auto” VAT setting for each category of goods or services you buy, which gives you at least a 50% chance of getting your VAT right.  It also helps you create VAT invoices which comply with HMRC’s rules, to give your customers.

HMRC’s website has a comprehensive guide as well, which can help you identify when you can and can’t claim input VAT, and how you should charge output VAT. You should also consider seeking advice from an accountant if you have any queries about any specific VAT issues.

Emily Coltman ACA is Chief Accountant to FreeAgent, who provides an online accounting system designed to meet the needs of small businesses and freelancers. Try it for free at www.freeagent.com

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