If you are completely new to VAT you might find the following overview helpful to understand the concept.

VAT was first introduced in 1973 when the UK joined the European Economic Community (EEC). It was the first tax in the UK to be based on European legislation. From January 1, 2021 the UK is no longer constrained by the EU VAT rules.

The notes below relate to the post-Brexit position from January 1, 2021.

By any other name, VAT is a sales tax although the way it is administered makes it slightly more complicated than a flat rate tax.

Overview

VAT is charged on most goods and services although some are exempt, some are outside the scope of VAT and others are charged at a zero rate, thereby effectively having no VAT cost.

VAT is charged by all businesses - either individuals, partnerships or limited companies - which are VAT registered in the UK. It is a criminal offence to charge VAT if your business is not VAT registered.

Also, VAT is charged on goods and some services that are imported from countries outside the UK.

A business which is registered for VAT can reclaim the VAT paid on any goods or services used in their business.

There are currently three rates of VAT, although these rates do change from time to time. The rates are:

1.     standard - 20%
   

2.     reduced - 5%
   

3.     zero - 0%
   

It’s Not That Simple

Why is VAT so complicated?

Unlike most tax which we encounter, such as income tax or capital gains tax, VAT relates to each specific transaction. So a business may make a sale and charge VAT on that sale - but if the next sale has different circumstances it may not be VAT-able.

A good example of this are accountancy fees. Where Cambridge Tax Practice invoices a client within the UK we are obliged to charge VAT. However, if a similar client is based outside the UK then we do not charge VAT (due to the “place of supply" rules).

Further complications arise because of the arbitrary way in which some goods or services are deemed to be zero rated. A famous tribunal case had to decide whether Jaffa Cakes were a cake or a biscuit - because one definition would mean standard rating for VAT and the other definition would mean zero rating. Another classic is the ‘hot pies’ case - cold takeaway pies are zero rated but hot takeaway pies are standard rated.

There are many such tribunal decisions.

How it Works in Practice

A VAT registered business will add VAT to the price they charge when they provide goods or services to business or non-business customers.

The VAT registered business will -

1.     charge VAT on the goods or services provided
   

2.     reclaim the VAT paid on goods and services used in the business
   

If a business is not a VAT registered then it cannot charge VAT to its customers, nor can it reclaim VAT on the cost of goods or services used in the business.

VAT Returns

When a business is registered for VAT then HMRC will expect quarterly VAT returns to be submitted. In each VAT return the business will disclose :

1.     the output tax (the VAT charged to customers)
   

2.     the input tax (VAT incurred by the business on goods or services)
   

The difference between these two figures will be the VAT paid to HMRC or repaid to the business.

HMRC recognise that small businesses can suffer late payment of invoices and therefore the VAT calculation can be made on a cash basis (cash received) rather than the strict basis which would be based on invoices issued.

Requirement to Register a Business for VAT

A business is obliged to register for VAT if :

1. the turnover for the previous 12 months has gone over the VAT threshold
   

2. there is an expectation that the turnover will soon go over this limit
   

The VAT threshold is currently £85,000.

However, if it is beneficial to the business then registration can be on a voluntary basis even if the above limits have not been reached.

Rates of VAT

There are different VAT rates and the rate charged will depend on the goods or services that are being provided. Currently there are three rates:

1.     standard rate of 20%
   

2.     reduced rate of 5%
   

3.     zero rate - 0%
   

In normal circumstances the standard rate of VAT will be the default rate and this is the rate which most businesses will charge. However, if the VAT rules specify that a particular situation will be charged at a different rate or is exempt then that will overrule the standard rate.

The reduced rate applies in fairly limited circumstances, the main example being the supply of domestic fuel and power.

Many goods and services are currently zero rated. Examples might include -

1.     food - but not meals in restaurants or hot takeaways
   

2.     books and newspapers
   

3.     children's clothes and shoes
   

4.     public transport
   

Other items can be exempt or outside the scope of VAT, for example -

1.     insurance (exempt)
   

2.     education and training (exempt)
   

3.     most services provided by doctors and dentists (exempt)
   

4.     non-business activities like a hobby (outside the scope)
   

5.     statutory fees such as vehicle MoT tests (outside the scope)
   

As an additional complication, some goods or services may be zero rated depending upon the location of the customer. This is known as the "place of supply" rules.

Full details of the zero rate and exempt supplies are on the HMRC website (now Gov.UK) at https://www.gov.uk/rates-of-vat-on-different-goods-and-services

Zero Rated / Exempt - What’s the Difference?

There is an important difference between exempt supplies and zero rated supplies. For VAT calculations any zero rated supplies still count as taxable supplies, even though the business doesn't charge VAT. However exempt supplies do not count as taxable turnover.

In practice, if you are supplying goods or services which are mainly exempt then you are unlikely to be able to recover the VAT on business costs.

Where a business supplies a mix of exempt supplies and zero or standard rated supplies then this is known as “partial exemption" and special rules are applied to decide how much VAT can be recovered on business costs.

Where Do I Go From Here?

Did this general guide answer your question?

Don’t worry if it didn’t - that’s the nature of VAT. If you have a particular problem, we can probably answer your question - so drop us an email using the link on our About Us page.