Tax

What is VAT (Value Added Tax)?

VAT is a tax added to most goods and services sold in the UK. Businesses collect it from customers and pay it to HMRC, minus any VAT they've paid on business purchases.

Current Rate (2025/26)

Standard rate 20%, Reduced rate 5%, Zero rate 0%

Example

You sell a £100 service, add £20 VAT (20%), charge customer £120. If you bought £50 of supplies with £10 VAT, you pay HMRC £20 - £10 = £10.

Key Dates

VAT returns usually quarterly, payment due 1 month and 7 days after quarter end

How VAT (Value Added Tax) Works in Practice

VAT is a consumption tax that is charged at each stage of the supply chain, but ultimately paid by the end consumer. As a VAT-registered business, you act as a collection agent for HMRC. You charge VAT on your sales (output VAT), reclaim VAT on your business purchases (input VAT), and pay the difference to HMRC each quarter.

There are three main VAT rates in the UK. The standard rate of 20% applies to most goods and services. The reduced rate of 5% applies to specific items like domestic fuel and energy, child car seats, and certain energy-saving materials. The zero rate of 0% applies to items like most food, children's clothing, books, and newspapers. Zero-rated items are still technically VAT-taxable, which is important because it means you can reclaim input VAT on purchases related to zero-rated sales.

Some supplies are VAT-exempt rather than zero-rated. The distinction matters. Exempt supplies include financial services, insurance, and education. If you only make exempt supplies, you cannot register for VAT and cannot reclaim input VAT. If you make a mix of taxable and exempt supplies, you must use partial exemption rules to work out how much input VAT you can reclaim.

VAT registration is mandatory once your taxable turnover exceeds £90,000 in any rolling 12-month period (from April 2024). You can also register voluntarily below this threshold, which makes sense if your customers are VAT-registered businesses who can reclaim the VAT, or if you make significant purchases with VAT that you want to reclaim.

Step by Step

Each VAT quarter, you total up all the VAT you charged on sales (output VAT) and all the VAT you paid on business purchases (input VAT). You submit a VAT return showing these figures in the standard 9-box format, and pay the difference to HMRC. If your input VAT exceeds your output VAT, HMRC refunds the difference.

Under Making Tax Digital, you must keep digital records and submit your VAT return through MTD-compatible software. You cannot manually type figures into the HMRC portal. Your software must have a digital link from your records to the submission.

The standard VAT accounting scheme means you account for VAT based on invoice dates, regardless of when payment is received. This can cause cash flow problems because you owe HMRC the VAT on an invoice you have issued even if your customer has not yet paid you. The cash accounting scheme, available to businesses with taxable turnover under £1.35 million, lets you account for VAT based on payment dates instead, which better matches your cash flow.

Practical Tips

Keep a rolling 12-month turnover tracker and review it monthly so you never accidentally breach the registration threshold without registering
Always keep valid VAT invoices for every input VAT claim, as HMRC can disallow claims without proper documentation during an inspection
Consider the cash accounting scheme if cash flow is tight, so you only owe HMRC the VAT once your customers have actually paid you
Set up a separate bank account or savings pot for VAT to avoid spending money that belongs to HMRC

Common Mistakes to Avoid

Not monitoring your rolling 12-month turnover and missing the mandatory registration threshold, which leads to backdated VAT liability and penalties
Reclaiming VAT on items that are not allowable, such as business entertainment, staff travel without proper receipts, or purchases with personal use
Confusing VAT-exempt and zero-rated supplies, which affects whether you can reclaim input VAT and how partial exemption rules apply
Filing VAT returns late or paying late, triggering HMRC's default surcharge regime which escalates with each late submission

Frequently Asked Questions

Do I need to register for VAT?

You must register if your taxable turnover exceeds £90,000 in any rolling 12-month period. You can register voluntarily below this threshold. Voluntary registration makes sense if most of your customers are VAT-registered businesses, as they can reclaim the VAT you charge.

How often do I submit a VAT return?

Most businesses submit VAT returns quarterly. HMRC assigns your VAT periods when you register. Payment is due one month and seven days after the quarter ends if you pay electronically. Some businesses on the Annual Accounting Scheme submit just one return per year.

Can I reclaim VAT on all business purchases?

You can reclaim VAT on most legitimate business purchases, but there are exceptions. You cannot reclaim VAT on business entertainment, purchases for personal use, or items where you do not hold a valid VAT invoice. Cars have special rules unless used exclusively for business.

What is the difference between zero-rated and exempt?

Zero-rated goods are taxable at 0%, meaning you can still reclaim input VAT on related purchases. Exempt supplies are outside the VAT system entirely, so you cannot reclaim input VAT on purchases related to exempt supplies. This distinction significantly affects your VAT recovery.

What happens if I charge the wrong VAT rate?

If you undercharge VAT, you are still liable to pay the correct amount to HMRC, which means the shortfall comes out of your pocket. If you overcharge, you must repay the excess to your customer. Getting rates wrong can also trigger penalties during a VAT inspection.

Source: HMRC VAT Notice 700 - The VAT Guide

Related Terms

VAT Threshold

The VAT threshold is the annual turnover level above which you must register for VAT. Below this, VAT registration is optional.

VAT Return

A VAT return is a regular submission to HMRC showing the VAT you've charged (output VAT) and paid (input VAT), with the difference paid or reclaimed.

VAT Flat Rate Scheme

The Flat Rate Scheme is a simplified VAT scheme where you pay a fixed percentage of your turnover to HMRC, instead of calculating VAT on each transaction.

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