What Is VAT?
Value Added Tax (VAT) is a consumption tax collected by VAT-registered businesses on behalf of HMRC. It's charged at each stage of the supply chain, but ultimately borne by the end consumer. VAT-registered businesses charge VAT on their sales (output tax) and reclaim VAT on their purchases (input tax), paying only the net difference to HMRC.
VAT raises roughly £170 billion per year — about a fifth of all UK tax revenue. It applies to most goods and services in the UK, with important exceptions for zero-rated and exempt supplies.
VAT Registration
Compulsory Registration
You must register for VAT if your taxable turnover exceeds the registration threshold of £90,000 in any rolling 12-month period. Once you breach this, you have 30 days to notify HMRC and registration takes effect from the start of the following month (or immediately if you knew you'd exceed the threshold in the next 30 days alone).
Voluntary Registration
Any business can register voluntarily below the threshold. This makes sense if you make significant purchases from VAT-registered suppliers, as you can reclaim input tax. It also makes your business appear larger and more established. The downside: additional administration and the need to charge VAT on your sales.
Deregistering
You can apply to deregister if your taxable turnover falls below the deregistration threshold of £88,000. You must deregister if you stop making taxable supplies.
VAT Rates
| Rate | % | Examples |
|---|---|---|
| Standard rate | 20% | Most goods and services, electronics, clothing (adult), professional services |
| Reduced rate | 5% | Domestic energy, children's car seats, stop-smoking aids, renovation of empty homes |
| Zero rate | 0% | Most food, children's clothing and footwear, books, newspapers, public transport, new dwellings |
| Exempt | N/A | Financial services, insurance, education, healthcare, some land/property transactions |
Zero-rated vs exempt: both carry no VAT, but the distinction matters. For zero-rated supplies, you can still reclaim input tax on related costs. For exempt supplies, you cannot — making partial exemption calculations necessary if you make a mix of both.
Input Tax and Output Tax
Output tax is the VAT you charge customers on your taxable sales. Input tax is the VAT you pay on business purchases, overheads, and costs. Your VAT return subtracts one from the other:
- If output tax > input tax: you pay the difference to HMRC.
- If input tax > output tax: HMRC repays the difference to you.
You can only reclaim input tax on costs that relate to your taxable business activities. Personal use, entertainment, and most car costs are blocked from reclaim.
VAT Returns and Making Tax Digital
Most businesses submit quarterly VAT returns online. Since April 2022, all VAT-registered businesses must use Making Tax Digital (MTD)-compatible software to keep digital records and submit returns. HMRC no longer accepts manual submissions.
Payment and the return are both due one month and seven days after the end of the VAT accounting period. Late filing and late payment attract surcharges, interest, and potentially a default surcharge regime.
VAT Accounting Schemes
Standard VAT Accounting
The default. You account for VAT on the invoice date — when you raise a sales invoice, not when you receive payment. You reclaim input VAT when you receive a purchase invoice.
Cash Accounting Scheme
Available to businesses with taxable turnover under £1.35m. You account for VAT when you receive payment (not when you invoice), which protects cash flow if customers are slow payers. You can only leave when turnover falls below £1.6m.
Flat Rate Scheme (FRS)
For businesses with taxable turnover under £150,000. Instead of tracking each sale and purchase, you pay a fixed percentage of your gross (VAT-inclusive) turnover to HMRC. The percentage depends on your trade sector and ranges from around 4% to 14.5%. You keep the difference between the VAT you charge customers and the flat rate percentage — but you cannot separately reclaim input VAT on purchases.
Whether the FRS saves you money depends on your level of VAT-rated purchases. Businesses with low costs (consultants, sole traders) often benefit; those with high materials costs often don't.
Annual Accounting Scheme
Submit one annual return instead of four quarterly ones. You make advance payments during the year (based on the previous year's VAT bill) and settle the balance on filing. Good for businesses that prefer to budget VAT payments but lose some cash-flow flexibility.
Record Keeping
Under MTD you must keep digital VAT records including: VAT account (a running total of VAT owed and reclaimed), copies of all sales and purchase invoices, and evidence of any adjustments. Records must be kept for at least 6 years.