A version of this article was first published here in May 2022.
Value added tax (VAT) can seem daunting and complex, and it can be costly if you get it wrong. Our VAT experts from FSB Tax Investigation Protection are here to take you through the basics, from whether you need to register, to how to calculate VAT prices.
What is VAT?
It's a sales tax added to eligible goods and services sold in the UK. Businesses that turnover more than £90,000 a year are likely to be required to register for VAT, charge it to their customers where necessary, and file a VAT return every three months.
How much is VAT?
The standard rate of VAT in the UK is currently 20%. Some goods and services have a reduced rate of 5%, some are zero-rated (0% VAT) and some are exempt from, or outside the scope of, VAT.
When registered, the rate of VAT you’ll need to charge and account for to HMRC will depend on the type of goods and services you sell.
View the government guidance for a detailed list of products, services and their UK VAT liabilities.
Who pays VAT?
In the tax system, you can only charge VAT if you’re registered. Once you’re required to be registered, you’ll carve out the relevant VAT from the total price paid by the consumer, and you’ll then pay this to HMRC via your VAT return.
Do I have to register for VAT?
As your business grows, you may reach the point where you need to register for VAT with HMRC once you exceed the threshold. Your accountant can help you with this. You’ll get a VAT number and will need to make VAT returns. Some businesses benefit financially from being VAT registered (mainly those that make mostly zero-rated sales or sell services to overseas customers), so if you wish to, you can VAT register voluntarily in advance of exceeding one of the compulsory registration thresholds.
You can’t register for VAT if you are not in business or if you only sell VAT-exempt goods and services.
Read our guide to VAT registration here.
VAT on purchases
On the plus side of having to pay VAT on sales income, VAT registered businesses can recover VAT charged to them by their suppliers as long as they hold valid UK VAT invoices, the supply is to the registered business entity, and the purchases concerned relate to its VAT taxable business activities.
How to calculate VAT
Once you’ve registered, your next step is to incorporate the correct rate of VAT into the price of your eligible goods and services.
How to add VAT to your prices
Let’s take an e-commerce website for UK consumers as an example. You usually sell your product online for £10, but now that you’re VAT registered, you’ll need to work out what rate of VAT to add (20%, 5%, 0%, outside the scope or VAT exempt). If your product falls under the standard rate of VAT, the new price you would display increases to £12.
Selling to other VAT registered businesses? Because they may be able to claim back the VAT, it’s common to show the prices excluding VAT, for example as £10 (ex VAT) to make it easier for your customer to understand their costs when they’re shopping.
If the customer is VAT registered or requests one, you’ll need to issue VAT invoices, sometimes known as VAT receipts. This helps your customers know how much VAT has been added and VAT registered customers need valid VAT invoices in order to recover this purchase VAT from HMRC.
So, if your customer has bought 10 products, you would charge them £120. On the invoice, you should include:
- your VAT number
- the pre-VAT price per item
- how much VAT you’re adding per item (as you may be selling items with different rates or that are exempt)
- the total cost inclusive of VAT
In this example, the pre-VAT price would be £100 with £20 of VAT, totalling £120. When you do your VAT return, you would add this £20 to your total VAT collected.
Alternatively, and especially when selling to consumers, you may not wish to increase your prices post-registration. You could therefore leave your price at £10 (using the above example). In this case, the VAT you would have to account for is within the £10; if the sale is subject to standard-rated (20%) VAT, the VAT within the £10 would be £1.67 (1/6 of £10); if the sale is subject to reduced-rated (5%) VAT, the VAT within the £10 would be £0.48 (1/21 of £10).
Whether you choose to keep your prices at £10 inc. VAT, £10 + VAT or some other price is a commercial matter for you to decide (and make clear to your customers), but whatever pricing you go for, the total amount payable by the customer (£12, £10 or some other amount) will include the appropriate amount of VAT which must be accounted for and paid to HMRC accordingly.
If you register for VAT late, any income you’ve received in the period between being required to be VAT registered and actually VAT registering will be considered inclusive of the applicable VAT. This means HMRC will require you to carve out the VAT owed to them from the income you have already had. In some cases, you may be able to require customers to pay you the VAT on top of what you have already billed them / received, but this will depend on the contractual pricing and nature of the customer (a VAT registered customer is more likely to agree to pay the VAT on top of the previously agreed price for example, than a private individual).