VAT: The Basic Principles

VAT (Value Added Tax) is a sales tax, levied on the expenditure of consumer goods and services and business transactions, which is paid by the consumer at the point of purchase and collected by Her Majesty’s Revenue and Customs (HMRC). First introduced to the UK in 1973, it is now a major source of revenue for the government.

There are four different categories for VAT: standard rate (17.5%) for goods and services considered to be ‘luxury’ items, reduced rate (5%) for goods and services considered to be socially or economically important, zero rate for essential goods and services and exempt rate for necessities. Some examples of zero-rated or exempt goods and services are: children’s clothes, food, public transport, newspapers, medicines, books, insurance, postal services and funerals. HR and Payroll¬†

For individual consumers, it’s a straightforward tax, paid at the point of purchase. For businesses, though, it’s a pretty complex system. However, put in simple terms, companies pay VAT on their purchases (known as input tax) and charge VAT on their sales (known as output tax).

All companies with an annual turnover of over ¬£60,000 must be VAT registered with HMRC, and must pay VAT on everything they buy and sell. When your company is VAT registered, you must submit VAT returns to HMRC on a quarterly basis to declare how much VAT you have charged your customers and to recover VAT for goods or services you’ve purchased. You’ll also need to set up a system of VAT invoicing for your sales, and all paperwork relating to VAT must be retained for VAT inspection, as HMRC carries out periodic VAT audits on all VAT registered companies.

You may wonder why some goods and services are zero-rated and some are exempt – what’s the difference? The answer is that a company can’t claim back the VAT on its purchases if that company sells only goods and services that are exempt.

Otherwise, many business to business transactions (in registered, taxable companies) on goods and services purchased in order to make further goods or services which are then sold on (directly or indirectly) to consumers are exempt and the VAT can be reclaimed – as the VAT is paid by the consumer at the end of the line. Input VAT from goods or services that your company has purchased can be recovered through your quarterly VAT returns. You’ll need to keep the VAT invoices you were issued in order to do this.

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