In our complex world of finance and taxation, Value Added Tax (VAT) stands as one of the pivotal elements that every UK business must navigate. But what exactly is VAT, why do we pay it, and how does it all work? Sit back and relax: in this guide, we answer those crucial questions. Whether you’re a seasoned entrepreneur or a first-time business-owner, this article should equip you with the knowledge and confidence to understand and submit successful HMRC VAT Returns for your UK business today.
What is VAT?
Value Added Tax (VAT) is a sales tax levied on the value added to goods and services at each stage of production and distribution. With its origins spanning back to pre-mediaeval times, this modern taxation system was implemented in the UK in 1973 as part of its alignment with the European Economic Community.
VAT can apply to all manner of business and trade, from buying a loaf of bread to purchasing professional services. As consumers in the UK, VAT is usually included in the up-front pricing of products and services we buy. As business-owners, we must be mindful to factor VAT into our pricing.
Note that, in some scenarios and jurisdictions – such as wholesale supermarkets or in the US – VAT might be excluded from pricing or calculated as an extra charge visible only at the check-out stage.
Why Do We Pay VAT?
The essence of VAT is to generate regular and useful revenue for the government. The tax supports various public services such as healthcare, education, and transport infrastructure. In addition, VAT also helps to level the economic playing field by taxing consumption rather than just income, providing a broader tax base.
Who Needs to Pay VAT?
The current VAT threshold is £85,000. This means that businesses exceeding £85,000 in taxable turnover in the last 12 months must register for VAT . You must also register for VAT if you expect turnover to exceed the same VAT threshold in the next 30 days. Once registered, your business must charge VAT on all eligible goods and services.
For businesses below the threshold, VAT registration is usually optional and referred to as voluntary registration. However, some businesses must register regardless of the VAT threshold and their taxable turnover. HMRC states that you must register for VAT if all of the following apply to you:
- you (personally) are based outside the UK
- your business is also based outside the UK
- you supply goods/services to the UK (or expect to in the next 30 days)
The exact turnover threshold could be changed in future, so it's crucial to stay up to date with the latest HM Revenue and Customs (HMRC) guidelines. Rest assured, though, if you use our service: AbraTax keeps abreast of guidelines and ensures long-term compliance.
How Much is VAT?
The current VAT is split into three separate rates, depending on the type of product or services you sell. The rates are: standard rate (20%), reduced rate (5%) and zero rate (0%).
Standard rate (20% VAT) is the default VAT rate, applying to the majority of products and services. Reduced rate (5% VAT) applies to a subsection of products and services, including elderly mobility aids, children’s car seats, and home energy supplies. Zero-rated (0% VAT) products include some charitable goods/services, human food and health products, freight transport, and essential utilities such as household water supplies.
HMRC provides a comprehensive list of rates (standard, reduced, zero, and VAT-exempt) here. Please note that some VAT rates differ between Northern Ireland and elsewhere. In addition, HMRC provides specific VAT guides for builders and charities.
Note that VAT rates may only apply when certain conditions are met, such as the manner or location of your sales, or the precise nature of your business’s products and services. HMRC sets out an overview of these conditions here.
Furthermore, some items are exempt from VAT (incl. postage stamps and property transactions) or simply lie outside the scope of VAT. See here for HMRC’s comprehensive list. In general, it is important as a business-owner to remember that VAT rates are subject to changes and adjustments; remember to keep yourself updated.
How Do I Calculate VAT?
VAT is a Value Added Tax – this means that you add VAT on top of the price of your goods and services. For instance, if you wish to sell a standard-rate product for £100, then you must add 20% on top of your intended sales price: £120. This is called the VAT-inclusive price. From this sale, the value-added £20 must be sent to HMRC, and your business will keep £100.
To calculate your VAT-inclusive price with standard rate, multiple your price by 1.2. To calculate for reduced-rate items, multiple your price by 1.05. For zero-rated or exempt products/services, there is no addition to be made to your prices – but remember to record this anyway.
How to Charge VAT for My Customers?
You must calculate the appropriate VAT rate for your products and services; present this calculation as part of your invoices and receipts for clients and customers, showing the specific VAT cost. Always remember to include your registered VAT number in business invoices.
Many business-owners find it useful to maintain a separate VAT account for VAT charges, ready to send the correct sum to HMRC in the upcoming VAT Return. You should also remember to keep a record of all your business transactions for later reference.
When Do I Pay My VAT Returns?
Most businesses must file an online VAT Return every 3 months. This is the new standard following the recent Making Tax Digital (MTD) initiative. The VAT Return tells HMRC how much VAT you have charged, and how much VAT you have paid to other businesses. From this, HMRC will generate your VAT bill and accept payment.
Your VAT Return and payment must be received by HMRC within one calendar month and 7 days after the end of the last accounting period (typically, the last quarter). For instance, if your last accounting period ended on 30 April 2024, then you would need to pay by 7 June 2024. HMRC provides a VAT payment deadline calculator here[AN13] .
How Do I File My VAT Returns?
Thanks to Making Tax Digital, VAT has entered the computing era. Most businesses are now required to keep digital records and file their quarterly VAT Return online. This has made the process more efficient, although it does require HMRC-recognised compatible software such as AbraTax.
There are 9 essential pieces of data from your business which are essential for each VAT Return. AbraTax helps you organise and submit these – our software even calculates some of these figures for you! Once you have filed your VAT Return online, payments can usually be made through various methods such as Direct Debit, online banking, or even by cheque.
Conclusion
Navigating the VAT landscape may seem daunting. However, armed with the right information, and backed up by compatible software, it becomes a manageable task. Always keep on top of the latest updates from HMRC or consult a financial advisor for personalised guidance. By understanding the essentials of VAT, you're not just complying with tax laws: you're becoming an informed, responsible business and contributing to society.
If you found this article helpful, why not check out our other articles on VAT and UK businesses?