SMALL BUSINESS RESOURCES

What is VAT?

5 min read

If you’re starting a new business in the UK, you may well be asking for the first time, ‘What is VAT’? Along with other important business considerations, dealing with HM Revenue and Customs (HMRC) and understanding value-added tax (VAT) are fundamental considerations. 

Why? Because getting your head around VAT is paramount to your new business remaining compliant with HMRC reporting rules. Of course, these rules are an important responsibility for any business.

For businesses in the UK, VAT is a fact of life. Many will assume you have all this consumption tax information covered. But what if you don’t? 

Let’s look at everything VAT – how much it is, how to deal with it, reverse charge, and the flat rate scheme.

What is VAT?

Value-added tax (VAT) is a consumption tax placed on a product in the UK whenever value is added at each stage of the supply chain. This applies from production to the point of sale. 

The amount of VAT that the consumer pays is on the cost of the product, minus any of the costs of materials utilised in that product, which have already been taxed.

What are the different types of VAT?

In the UK, there are three primary modes of VAT. 

  • Standard rate VAT – 20%
  • Reduced rate VAT – 5%
  • Zero rate VAT – 0%

Let’s unpack these different rates further to understand when they apply and for which products and services.

How much is VAT?

The standard VAT rate is 20%. 

Certain items are deemed exempt from this value added tax, including postage stamps, financial and property transactions.

However, this standard rate may change depending on the goods your business deals with or offers for sale. Let’s look at the three main rates.

Standard VAT rate

Most goods and services are subject to the standard VAT rate of 20%. You should almost always charge this standard rate unless the goods or services your business offers are categorised as ‘reduced VAT’ or ‘zero-rated VAT’.

Reduced VAT rate

Applying reduced rate VAT depends entirely on what the item is, as well as the specific circumstances around the sale. For example:

  • children’s car seats
  • domestic fuel or power
  • mobility aids for older people

Zero-rated VAT

Zero-rated VAT means that the goods sold are still VAT-taxable. The point is that the rate of VAT you must charge your customers is 0%. 

To manage this, your business must record such sales in your accounts, and you must report them on your VAT Return to the HMRC. Examples include:

  • books and newspapers
  • children’s clothes and shoes
  • most goods you export to non-EU countries
  • goods supplied to a VAT registered EU business

VAT Online

Luckily, in this day and age, you can easily submit VAT online. In many circumstances, your business may file your VAT Return online with the HMRC. Returns must be completed quarterly. 

However, if you’ve signed up for Making Tax Digital (MDT), you must instead use compatible accounting software such as Reckon One to submit VAT online, which will automate the process.

How do you register for VAT online?

Almost all businesses can register for VAT online. This includes UK based partnerships and groups of companies operating under a single VAT number.

By registering for VAT online, you’ll create an online account. Your account will be used to submit your VAT Returns to HMRC.

You also have the option of appointing an advisor, accountant, or agent to register for VAT and interact with HMRC on your behalf.

Pay VAT Online

There are options to pay VAT online as well as various other payment methods such as by phone or direct debit. All payments must reach HMRC by your deadline or potentially face a penalty. 

You can pay directly online, or through CHAPS or Bacs. 

Online VAT return

To compete your online VAT return, you need a VAT number and an online account. HMRC’s free online service is available for online VAT returns. If you’re signed up for MDT, you should use appropriate commercial accounting software to submit your value-added tax.

Reverse Charge VAT

If you’re a UK business engaged in B2B transactions within the EU, you should be aware of reverse charge VAT, which is designed to counter forms of fraud within the system. 

Essentially, the onus falls on the buyer in this instance by moving responsibility for the reporting of a VAT transaction away from your business. 

When reverse charge VAT is in play, the buyer of your goods reports their purchase (input VAT) on top of the supplier’s (your) sale (output VAT) in their return.

VAT Flat Rate Scheme

The VAT flat rate scheme is an alternative and simplified way of paying tax to HMRC. It can only be used by businesses turning over less than £150,000 (excluding VAT).

With the flat rate scheme, your business pays a fixed percentage of its annual turnover to the HMRC instead of on every sale.

This doesn’t suit every small business, so please speak to a qualified accountant or advisor before considering this method of paying VAT. To use the scheme, you must register with HMRC.

What items are exempt from VAT?

Differing from zero rated VAT, there are certain products and services that attract no VAT and are known as ‘exempt’ or VAT exemptions. VAT isn’t charged for the following and you don’t include them in your taxable income:

  • insurance, finance, and credit
  • education and training
  • fundraising events by non-profits and charities
  • subscriptions to membership organisations
  • selling, leasing, and letting of commercial land and buildings – this exemption can be waived

What does VAT stand for tax?

VAT stand for ‘value-added tax’. VAT is classified as both a general tax and a consumption tax.

What is the VAT rate UK 2021?

While the standard rate of 20% and the reduced rate of 5% haven’t changed through the events of 2020/21, there have been some temporary alterations to assist the hospitality and tourism sectors.

  • From 15 July 2020 to 30 September 2021 the reduced rate will also apply to the tourism and hospitality industries.

We hope this information has assisted you to understand what VAT is, how it works and how it applies to businesses, products, and services. For more information, we have a hub of information on VAT available for further reading.