What do I need to know about VAT?

Value Added Tax (VAT) is a tax charged on many goods and services supplied by VAT-registered businesses.

A VAT-registered business charges VAT to its customers at the rate that applies to the goods or services being supplied. While many supplies are subject to the standard rate of 20%, some are charged at a reduced rate, zero-rated or exempt from VAT.

The customer pays the VAT to the supplier as part of the purchase price. The supplier then accounts for the VAT and pays it to HM Revenue & Customs (HMRC) through the VAT system.

This VAT does not belong to the business collecting it. The business is acting on behalf of HMRC.

Where a customer is VAT registered, they may be able to reclaim some or all of the VAT charged to them, subject to the normal VAT recovery rules.

The amount payable to, or reclaimable from, HMRC is reported through the VAT Return.

There are three main rates of VAT. The rate that applies depends on the goods or services being supplied.

The main rates are:

• Standard rate (20%) – applies to most goods and services.

• Reduced rate (5%) – applies to certain supplies, such as domestic fuel and power.

• Zero rate (0%) – applies to certain goods and services, including children’s clothing, books, newspapers, public transport and many food items.

Some goods and services are also exempt from VAT. Unlike zero-rated supplies, exempt supplies are outside the VAT system and are subject to different VAT recovery rules.

If you are unsure which VAT rate applies to a particular product or service, check the latest HMRC guidance before issuing an invoice.

You’ll need to charge VAT when your business is:

• registered for VAT (either voluntarily or because registration is required); and

• makes a taxable supply of goods or services.

Taxable supplies include sales that are, standard, reduced and zero-rated. Although no VAT is charged on zero-rated supplies, they are still treated as taxable supplies for VAT purposes.

Some supplies are exempt from VAT, including certain financial services, insurance, education and healthcare services.

Other transactions may fall outside the scope of VAT altogether. Examples include:

• wages and salaries paid to employees

• dividends received from investments

• statutory fees and charges imposed by government bodies.

Exempt and outside-the-scope transactions are generally not included when calculating a business’s VAT taxable turnover.

When issuing invoices or checking invoices you have received from suppliers, you should ensure that the correct VAT treatment has been applied to the goods or services being supplied.

VAT registration can affect the price your customers pay, particularly if they are not VAT registered themselves.

If you currently charge £100 for a product or service and then become VAT registered, you may decide to add VAT on top. At the standard rate, this would increase the customer price to £120.

However, you could also choose to absorb some or all of the VAT cost within your existing price. This would reduce the amount you keep from the sale, so it is important to consider pricing carefully.

The effect on customers will depend on who you sell to:

• VAT-registered business customers are likely to be able to reclaim the VAT you charge, subject to normal VAT recovery rules.
• Private customers and non-VAT-registered businesses cannot reclaim VAT, so any VAT added to your prices will increase their cost.

For example, a painter and decorator who works for both commercial and private customers may find that VAT registration has less impact on commercial clients who can reclaim VAT, but more impact on private household customers who cannot.

Being VAT registered may make your business appear more established to some customers and suppliers. However, whether VAT registration is beneficial will depend on your pricing, customers and costs.