What is VAT?
Value Added Tax (VAT) is a tax charged on most goods and services supplied by VAT-registered businesses in the UK. Businesses registered for VAT generally charge VAT on taxable sales and may be able to reclaim VAT paid on eligible business purchases.
VAT is ultimately designed as a tax on consumption, although VAT-registered businesses play an important role in collecting and reporting it to HM Revenue & Customs (HMRC).
What are the UK VAT rates?
There are three principal rates of VAT in the UK: the standard rate of 20%, which applies to most goods and services; the reduced rate of 5%, which applies to a limited range of goods and services such as domestic energy; and the zero rate of 0%, which applies to certain goods and services including most food and children's clothing.
It is important to distinguish between zero-rated and VAT-exempt supplies. Both may result in no VAT being charged to the customer, but their VAT treatment is different.
How does VAT work?
A VAT-registered business will generally charge VAT on its taxable sales. This is known as output VAT.
It may also pay VAT when purchasing goods and services for the business. This is known as input VAT.
The business normally calculates the difference between eligible input VAT and output VAT when completing its VAT Return.
VAT example
Suppose a VAT-registered consultancy invoices a client £10,000 for services, plus VAT at 20% of £2,000. The £2,000 represents output VAT collected from the customer.
If the consultancy also incurred £3,000 of qualifying business expenditure plus £600 VAT during the VAT period, it may be able to reclaim the £600 as input VAT. With output VAT of £2,000 and input VAT of £600, the net VAT payable to HMRC would be £1,400. The actual amount reclaimable depends on the nature and use of the expenditure and applicable VAT rules.
When does a business need to register for VAT?
A business generally needs to register for VAT when its VAT-taxable turnover exceeds the statutory registration threshold, currently £90,000. VAT registration should be monitored carefully because the test is based on taxable turnover rather than accounting profit, and it is measured on a rolling 12-month basis rather than by financial year.
What is VAT-taxable turnover?
VAT-taxable turnover broadly represents the total value of sales that are not exempt from VAT, including standard-rated, reduced-rated and zero-rated sales. VAT-exempt sales are treated differently and are generally excluded from the taxable turnover calculation. Understanding this distinction is important when determining whether a business has crossed the VAT registration threshold.
Can a business voluntarily register for VAT?
Yes, a business can choose to register for VAT voluntarily even before it reaches the registration threshold. Potential reasons include being able to reclaim eligible input VAT and dealing primarily with VAT-registered business customers who can reclaim the VAT charged to them.
What is input VAT?
Input VAT is VAT incurred by a VAT-registered business on qualifying purchases and expenses. Subject to the relevant rules, some or all of this VAT may be recoverable.
What is output VAT?
Output VAT is VAT a VAT-registered business charges on its taxable supplies. Businesses generally report output VAT to HMRC through their VAT Returns.
What is a VAT Return?
A VAT Return reports information including VAT charged on sales and VAT incurred on eligible purchases. Most businesses submit VAT Returns every three months, although other arrangements can apply, such as the VAT Flat Rate Scheme or annual accounting.
VAT for startups and growing businesses
VAT can become particularly important for growing businesses because registration is driven by turnover rather than profit. A startup can therefore become liable to register for VAT even while generating relatively little accounting profit, so tracking rolling 12-month turnover from an early stage is worthwhile.
VAT and international businesses
The VAT treatment of international transactions can be more complicated, with different rules applying to goods versus services and to trade with the EU versus the rest of the world. Businesses expanding into or trading with the UK should therefore establish their VAT position early, since overseas businesses may face different registration thresholds and obligations to UK-based ones.
What does VAT stand for?
VAT stands for Value Added Tax.
What is the standard VAT rate in the UK?
The standard rate of VAT is currently 20%.
Is VAT charged on profit?
No. VAT is fundamentally different from Corporation Tax. VAT generally relates to taxable supplies, whereas Corporation Tax is primarily calculated on taxable company profits.
Can businesses reclaim VAT?
VAT-registered businesses may be able to reclaim VAT incurred on eligible business expenditure, subject to the VAT recovery rules.
Is zero-rated the same as VAT exempt?
No. Zero-rated supplies remain taxable supplies but are charged at 0%. Exempt supplies have a different VAT status, which can affect VAT recovery and taxable-turnover calculations.
Related terms: VAT Registration, VAT Registration Threshold, VAT Return, Input VAT, Output VAT, Taxable Turnover, Zero-Rated VAT, VAT Exempt, Reverse Charge VAT.
Explore our VAT and Tax & Compliance resources for more information about VAT registration, reporting and managing tax obligations as your company grows.
VAT rules depend on the nature of transactions and individual circumstances. This glossary provides general information and is not personalised tax advice.