UK Business Information / Value Added Tax (VAT)

1. VAT Overview

VAT is a tax that VAT-registered businesses charge on most goods and services they supply in the UK for VAT purposes. The UK consists of Great Britain, Northern Ireland, the Isle of Man (excluding the Channel Islands and Gibraltar).  

VAT is a tax on consumer spending that is collected by VAT registered businesses on  transactions and imports. The basic principle of VAT is that businesses charge VAT at each stage in the supply chain of goods or services (output tax). If the customer is also registered for VAT and uses the supplies for a fully taxable business purposes, the customer will receive credit for this VAT (input tax). Broadly, VAT should be a tax that is borne by the final consumer.

For supplies of goods or services to be within the charge to UK VAT, the supply must be made in the UK. Supplies made outside the UK are outside the scope of UK VAT (although the supply may be liable to VAT in another country).

It should be understood that separate rules apply for determining the place of supply of goods and services.

2. Tax Rates & Exempt Items

In the UK, there are currently three rates of VAT:

• The standard rate of 17.5% - this is charged on the majority of goods and services supplied in the UK. This was temporarily reduced to 15% during the period 1 December 2008 to 31 December 2009 inclusive.
• The reduced rate of 5% - this is charged on items such as domestic fuel or power, children’s car seats, certain types of property conversions  to name a few; and
• A zero rate of 0% - this is for a limited number of goods including some construction services to charities, supplies of food (not catering), books and newspapers, young children’s clothing etc.

Zero-rate means that although output tax is not charged on the supplies made, input tax on costs and expenses is reclaimable subject to the normal rules on input tax recovery.

In addition, zero-rated supplies are still ‘taxable’ supplies and count towards the VAT registration threshold when determinging if a business is required to register for VAT.

Some services are exempt from VAT. These services include certain types of finance, some land and property transactions, insurance and certain types of education and training.

The value of exempt supplies does not count towards the VAT registration threshold when determinging if a business is required to register for VAT.

3. Taxable Turnover and Registration

Businesses will need to register for UK VAT if their level of taxable supplies exceeds the VAT registration threshold (currently £68,000).

There are two tests to consider when determining if a business has a liability to register for UK VAT – the historical test and the future test.

The Historical Test

A business is required to notify HMRC within 30 days of the end of any month if the value of their taxable supplies in a period of twelve months then ending exceeds the VAT registration threshold,; or

The Future Test

A business is required to notify HMRC within 30 days in which there are reasonable grounds for believing that the level of their taxable supplies in the period of 30 days will exceed the VAT registration threshold.

Some services received from abroad, such as consultancy, accountancy or professional services are treated as if the company supplied them, and so they must be included in their taxable turnover when determining if a business has a liability to register for UK VAT.

If a business takes over another business or part of a business as part of a Transfer of a Business as a Going Concern, the rules above still apply, but the turnover of the previous owner must be taken into account.

Businesses that are required to register for VAT must send the relevant forms to HMRC within 30 days of the two situations mentioned above. In some situations, a company may exceed the taxable turnover threshold even though they only sell zero-rated goods. In this situation, the business may not have to register, although they will need to apply to be exempt from registration.

4. How Does VAT Work In The UK?

If a firm is registered for VAT, they are required to keep proper records of all transactions for a period of six years. From the time that they know that they are registered, companies must issue a VAT invoice to any customers who are registered for VAT, which contains information, amongst other things, such as their VAT registration number, name and address of their company, the price of the goods before VAT and the VAT charged on the goods (must show the rate of VAT on goods).

Proper VAT records will include:

• Details of all standard-rated goods and services supplied or received by the company
• Details of any exempt supplies made
• A VAT account

In the UK, the VAT a business pays to HMRC is the difference between their output and input tax. Both will be explained below.  

Output Tax

The output tax of a business is the amount of VAT that it charges on goods and services supplied. Hence, output tax is the tax that the business collects from their customers when they make a sale, which is paid over to HMRC.

Output tax is worked out by multiplying the net value of a good / service supplied by the tax rate.

If the business supplies goods that have different VAT rates, then they must calculate the VAT separately for each supply at the rate at which it is charged.

With regards to exported goods / services, generally exports of goods are zero-rated, though this depends on their destination and also if the company meets certain conditions. Service exports normally are zero rated or outside the scope of UK VAT, though some may be standard-rated.

Input Tax

Input tax is the VAT that businesses pay out to their suppliers on any purchases that are liable to VAT at the standard or reduced rate. It also includes VAT charged on imported items (some restrictions apply), on overheads and research and development costs, and normally on goods that are imported into the UK.

In general, input tax can only be reclaimed once a business is registered for VAT, although in some circumstances input tax incurred before a firm’s registration date can be claimed back. Businesses can also claim back the output tax already paid to HMRC on debts that remain unpaid for more than six months from the later of the date of the supply or date the invoice became due and payable. 

Businesses that incur input tax can normally claim it back if it relates to their normal business use.  However, there are some items where businesses cannot claim back the input tax - to name but a few, VAT on the purchase of cars, business entertainment and items that do not directly relate to the business (namely items for private use). Once a business has calculated its output and input tax, it either pays the difference to HMRC (if the output tax is greater than the input tax – this is normally the case) or it can reclaim any tax owed to them by HMRC should input tax be greater than output tax.

5. Paying VAT

Businesses that are registered for VAT will have to fill in VAT returns at regular intervals during throughout the year, normally every three months, although businesses that are in a regular repayment position to request monthly VAT returns.

The period that the return covers is the company’s tax period, which can be altered if the company wishes to match their accounting period. The VAT return generally records a company’s output tax and input tax for the period, and hence will determine how much they owe / are owed by HMRC.

A business is required to submit its VAT return and make payment to HMRC by the last day of the month following the end of the return period. If returns are submitted electronically, it is a requirement that any payment is also made by electronic means. Payments made by electronic means will automatically receive a seven day extension for both the submission and payment of VAT returns.

Payments must be in HMRC's bank account on or before the 7th calendar day from the standard due date. If the 7th day falls on a weekend, the payment must be received by the previous Friday. If the 7th day falls on a bank holiday, payment must be received by the last working day beforehand

In the event the VAT return and or payment is submitted late, the business may be subject to a default surcharge penalty which is based on a sliding scale and calculated as a percentage of the businesses net liability.

Although businesses can get professional help in filling out their VAT returns, it is ultimately their responsibility that the details they send to HMRC are accurate. Any errors in the return that result in underpayment of VAT constitutes an offense under UK law.

6. Imports / Exports & Reverse Charges

VAT is not only chargeable on the supply of goods and services that are deemed to be supplied in the UK. It can also be charged on goods and services imported. If goods are imported from outside the EC, then VAT is normally due at the same rate as if the goods were purchased from within the UK. Usually, VAT is paid when the goods are imported, although some businesses are entitled to defer the payment of VAT.

Normally the supplier of a service is required to account for any VAT due on a  supply to HMRC. However, in certain situations, the position is reversed and it is the customer who must account for any VAT due. This is known as the 'reverse charge' procedure.

The consequence of this is that anyone carrying on a business in the UK will become liable to be registered for VAT if the total value of reverse charge services within these provisions and turnover from any taxable business supplies made in the UK exceed the VAT registration limit.

Where the reverse charge procedure applies, the recipient of the services must act as both the supplier and the recipient of the services.