How VAT works in the UK

Every business thinks about tax. Do I need to pay it? How much? When’s the deadline? Have I got my figures correct? When you register as a new business one of the most commonly asked questions is: do I need to register for Value Added Tax (VAT)? In this post we’ll explain what you need to know about how VAT works in the UK.

How does VAT work in the UK?

VAT is a sales tax that is charged on all goods and services where the business has an annual turnover of £85,000 or more.

Once your business reaches this turnover threshold, you must register with HMRC and charge VAT (usually currently 20%) on the goods or services you sell to customers and other businesses. You must also pay VAT on goods and services from other VAT registered businesses. However you may decide that you wish to register before your turnover reaches this amount so that you can reclaim VAT you are being charged.

Each quarter, a VAT registered business must submit a VAT return via software approved for the government’s Making Tax Digital programme. This tax return calculates the difference between VAT that you charge your customers and VAT that you have been charged. Any difference is an amount you need to pay, or get a refund from, HMRC.

How does it need to be listed to a customer?

When adding VAT to invoices, it must be listed separately to the cost of goods and services. This will allow the recipient to process the charges in their accounting system, if they are VAT registered themselves.

Are there different VAT rates?

Yes, there are three different rates of VAT:

• Standard (20%) – Most goods and services where VAT is applied is applied at this rate
• Reduced (5%) – Certain goods and services are charged at this special rate. Eg home energy, children’s car seats
• Zero (0%) – Where no VAT is charged. This applies to many food and drink items that you would buy in the supermarket. Children’s clothes are also VAT free.

A full list of goods and services, and the VAT rate to be charged can be found here on the UK government’s website.

Different VAT schemes for businesses

To help small businesses the government has designed three different schemes to simplify the process:

Flat rate VAT scheme

– for businesses with a turnover of less than £150,000 per year. With this scheme, you don’t need to keep a record of the VAT you charge on every sale. Instead, VAT is calculated as a percentage of your total VAT-inclusive turnover. However the rules on using this scheme means it only suits a certain type of business.

Cash accounting scheme

– here you only pay VAT when your clients pay you. This means that you can only reclaim VAT once you’ve paid your own suppliers. Only businesses with a turnover of less than £1.35 million can use the cash accounting scheme. This is a very commonly used scheme and most small business will be on the cash accounting scheme

Annual accounting scheme

– this scheme is aimed at helping VAT-paying businesses reduce their admin by only submitting one VAT return a year rather than four. From this single return, businesses will pay their VAT in instalments. Like the cash accounting scheme, turnover needs to be no more than £1.35 million per year.

What about VAT from European Union countries?

Some of this will change if the UK leaves the EU without a deal.

Currently, if you sell to or buy from a business in an EU-VAT registered business operating in another EU country, you don’t usually charge VAT on that sale.

However, there are some exceptions, such as if you are selling to the final customer in another EU country.

To work out if you need to charge VAT within the EU, the European Union website has a specific page that will help you work out whether you should be charging VAT.

In most cases, an invoice that you receive from a business within another EU country will indicate if VAT has been applied. EU VAT registered businesses will indicate they are registered by including their VAT registration number just as a UK company would. Your accounting solution will then allow you to add an invoice in listed as Reverse Charge VAT.

What about invoices from outside the European Union?

If you receive invoices from outside the EU, what you need to enter depends on whether this is for goods or services. Again, the EU provides all the information you need here.

What VAT can I claim back?

Common questions we often get asked are what VAT can I claim back and how can it be reclaimed? As a general rule of thumb, businesses can reclaim VAT paid on goods and services purchased for business use, with some exceptions.

Businesses reclaim back the VAT by submitting a VAT return to HMRC. In order for HMRC to pay what is owed to you they need your bank details. To view any refunds you’re owed, you can use your online account (unless you’ve signed up for Making Tax Digital for VAT).

Common VAT mistakes

Sometimes it’s not always that clear on what you need to charge and when you can claim back VAT. Here are a list of some of the most common mistakes businesses make:

1. Business entertainment costs – that crate of champagne you shared with your client may have tasted amazing and seemed like a great idea at the time, but you won’t be able to claim the VAT.
2. Staff entertainment costs – conversely, where you’re entertaining staff (including directors of your own company) you can claim the VAT back.
3. Claiming VAT for non-business use expenses – when you’ve incurred expenses which is partly business and partly personal, you can only claim for the part that relates to business use.
4. Incorrectly claiming for VAT on fuel/mileage – of the government’s standard claim rate of 45p per mile, VAT can only be claimed on 11p of each mile.

How do I submit a VAT return?

Since April 2019, HMRC introduced their long-awaited initiative, Making Tax Digital. This means that VAT registered businesses will need to submit their VAT return electronically. In most cases a business’ accounting solution will perform that action for them so it is relatively easy for a business to move towards the digital age when it comes to VAT.

VAT on cars, vans and second hand goods

When buying a new car you may be able to reclaim all the VAT back, if you only use if for business use and not personal (which you have to prove). However, if you lease a car, you will only be able to claim 50% of the VAT, unless you can prove that the car is only for business use (again you will have to prove this).

When buying a commercial vehicle (like a van, lorry etc.) all the VAT can be reclaimed, again if it is not used for personal reasons too (starting to sound like a broken record). If you would like more information on this you can visit Gov.uk.

When it comes to second hand goods, you can use the VAT margin scheme, which tax the difference between what you paid for an item and what you sold it for (rather than the full selling price). Essentially you end up paying one-sixth on the difference.

This scheme isn’t just available for second hand goods, you can also use it for works of art, antiques and collectors’ items.

VAT on leased items

Whether tax relief is available or not when acquiring business assets depends on many factors such as:

• Did you buy the asset outright?
• What type of lease do you have?
• What is the length on the lease?

The above factors also affect whether VAT will be charge upfront or periodically.

In most cases, the cost of renting or leasing an asset is deductible as a business expense, which can reduce your overall tax bill.

If the intention is to own the asset after the lease period has come to an end, this is known as a ‘supply of goods’. This means you have to pay VAT on the whole value at the start of the contract. If you want to reclaim VAT and sell the asset, you may be required to have an account for VAT on your selling price.

If you won’t become the owner on the asset at the end of the lease period, this is known as supply of services instead, which means VAT can be paid periodically.

What do I do if I need help understanding all this further?

As you’d expect from a firm of accountants, we can help you understand when you need to charge VAT or not, how to go about registering and with any other enquiries about VAT. Simply complete the form below or give us a call on 0333 200 0714.