Skip to content

TAX •  28 OCTOBER 2022 • 6 MIN READ

What's VAT

a person is calculating using a calculator calculating the tax needs to be paid to HMRC

Value Added Tax (VAT) is a tax on most goods and services sold by businesses. While it feels like a tax on businesses, it really isn’t. Instead, it’s ultimately paid by people living out their day-to-day lives.

Businesses act like tax collectors for the government – charging an additional 20% (or sometimes 5%) on top of each sale, which they later forward to HMRC.

A business’s process of forwarding the VAT to the government is called a VAT Return.

What are taxable goods and services?

Taxable goods and services are the goods and services that you supply and receive in return for a consideration (money, compensation or reward). This is irrespective of whether you’re producing a profit or not.

Goods include all types of personal and real property except money. While services cover everything else besides goods and money. Imagine things like consultations with a legal advisor or having your car repaired.

It’s also important to know what taxable goods and services don’t include. These are goods and services supplied by businesses that aren’t registered for VAT, along with exempt supplies such as: 

  • Letting or renting a dwelling for use as a private home
  • Insurance, finance and credit
  • Education and training
  • Fundraising events by charities
  • Subscriptions to membership organisations
  • Selling, leasing and letting of commercial land and buildings (unless this exemption is waived and an Option To Tax (OTT) is made)
  • Bank fees
  • Salaries and wages

How much is VAT?

The VAT standard rate is 20% in the UK for most goods and services. A reduced rate of 5% applies to goods and services such as children’s car seats and fuel for the home. There is also a zero-rate of VAT which applies to most food and to children’s clothes. Finally there are goods and services which are exempt from VAT all together, which we listed above. 

To calculate the VAT inclusive price, simply multiply the price by 1.2 (standard rate) or 1.05 (reduced rate);  while for a VAT exclusive price, divide your price by 1.2 (standard rate) or 1.05 (reduced rate).

How does VAT work?

As a business, you’re acting as one of the government's agents by collecting VAT on your product or service. At the same time, your business is also contributing VAT each time it buys something (and for most purchases, you’re eligible to have the VAT refunded).

At the end of each VAT period (usually every 3 months for most businesses in the UK), you need to calculate the difference between the amount of VAT you’ve collected and the amount you’ve paid on goods and services to figure out if you pay more to the HMRC, or receive a refund.

Here is an example. If you are VAT registered, and your hourly rate is £100 per hour plus VAT. This means, your customers will pay £120 (£100 + £100 * 20%) in total to you for one hour of your service. If you purchased a new laptop for your business at the price of £1,200, the VAT component (£200) on this new laptop can be claimed back.

In summary, as a business owner, 

  • You may need to add VAT to your sale prices
  • You need to pay VAT you collected from your customers to HMRC
  • You can claim back the VAT that you’re charged on the purchases for your business

VAT on special transactions 

Zero-rated supplies

Zero-rated supplies are supplies that are subjected to a VAT rate of 0%. It’s different from exempt supplies (we will cover this in the next section) which doesn’t attract VAT in the first place. The most common zero-rated supplies relate to exported goods and food and drink for human consumption. 

Even though the VAT rate is at 0%, you still need to include the transactions in your return.

Exempt supplies

It’s crucial to know exempt supplies and zero-rated supplies are different. The VAT component is not subjected to these exempt supplies such as education and training, and residential rental property income.

You don’t include them in your VAT return and if the exempt supplies are all you sell, you can’t register for VAT. 

Digital service providers

If you are a business making supplies of digital services to UK consumers, those supplies are Subject to UK VAT. Therefore, digital service providers such as softwares, apps, ebooks, and subscriptions are subject to VAT if their income in the UK passes the VAT registration threshold of £85,000. As a business, these types of expenses can be claimed back. 

However, less well-known or smaller digital service providers may not be VAT registered so you can’t claim back the VAT you have spent on these services. Nonetheless, you should keep records of those larger transactions.

If you are a UK supplier of digital services to consumers outside the UK, then these supplies are not liable to UK VAT, but you may be liable to VAT in the country where the consumer is based.

Donations

If your VAT-registered organisation receives a donation with ‘no strings attached’ it’s not subject to VAT. ‘No strings attached’ means the giver or payer has made a voluntary donation and expects nothing in return.

However, if you are selling goods (e.g. fundraising activities) or services (e.g. a tour) in exchange for donations, you need to collect and pay VAT to HMRC.

Charities 

Charities receive income from a range of sources. If the charity is VAT registered then VAT will need to be charged on the sale of goods and services as normal. As above, genuine ‘no strings attached’ donations will not be subject to VAT. 

Charities will be able to claim relief from VAT on the goods and services they buy, regardless of whether the charity is VAT registered. Charities are able to request that suppliers charge them the reduced rate (5%) or zero-rate (0%) on supplies that would ordinarily be charged at the standard 20% rate. This is particularly beneficial to non-VAT registered charities. 

Property and land transactions

VAT on property and land transactions can get complicated. But the general rule is residential property sales are exempt from VAT (except in the case of new build homes where they are zero rated). 

The sale of commercial land and buildings is exempt from VAT, unless it is new (less than three years old) or the seller has made an Option To Tax (OTT).  

When you are buying or selling residential or commercial properties, it’s very important to run it past your accountant before signing any sale and purchase agreement because the cost of mistakes can be huge and difficult to make right. 

Do you need an accountant for VAT?

You don’t necessarily need an accountant or tax agent to file your VAT returns. However, the complexity arises and there will be more tax admin involved as your business grows. Besides, as business owners, handling taxes and meeting tax compliance due dates can be stressful at times. Therefore, seeking professional advice will be less time-consuming and less costly. Check out our bookkeeping service here.

Key Takeaways

The standard VAT rate is 20% in the UK. There is also a reduced rate of 5% and a zero-rate. VAT is added to most of the goods and services in the UK. You are obliged to register for VAT if your annual turnover exceeds £85,000 in the past 12 months or you expect your turnover to go over £85,000 in the next 30 days. If your business’s turnover has not met the threshold, you don’t need to register for VAT unless you voluntarily choose to do so. We have an in-depth guide explaining VAT registration if you want to know more about this topic.

If your business is VAT registered, you need to charge your customers another 20% (or 5%) on top of your sale price except for the items that are exempt from VAT or are zero-rated. In other words, this additional 20%/5% will be passed on to your customers. As a business, you could also claim back the VAT paid for your purchase. 

VAT rules vary on special supplies and transactions such as zero-rated supplies, exempt supplies, donations, and property and land transactions. Before signing any paperwork for property and land transactions, it’s important to consult with your accountant or tax agent due to its complexity. 

It’s also important to keep records of the sales and purchases such as receipts and invoices for at least 7 years in case HMRC wants the proof.

Who are Beany? 

We’re an online accounting firm that is always right here for you, your accounting pain relief. The most advanced technology lets us work way more closely with you than a normal accountant world. ​

We have a dedicated team of certified accountants and a support team to take care of your business no matter where you are, so you can focus on growing your business. We take out the ‘fluff’, break down the barriers and get things done. Looking out for you is what we are all about. Get started for free today.

Charlotte

Got any questions about Beany?

Chat to one of our friendly team today to get clarity.

Charlotte

Charlotte Wass

General Manager, Beany UK

Chartered Accountant and Chartered Tax Adviser based in London. I love autumn, otters and Malteasers, and I hate spiders, peanut butter and the London Underground.

subscribe + learn

Beany Resources delivered straight to your inbox.

Beany Resources delivered straight to your inbox.

Share:

Related resources

View all resources
View all resources