Value Added Tax Explained

Value added tax, generally known as VAT, is levied on the majority of goods and services supplied by UK VAT-registered businesses and when goods are imported into the UK. This article is particularly relevant to the CII R03 and AF1 exams.

Registering for VAT

If a firm produces taxable supplies, that is goods or services liable to VAT, then they will have to register for VAT once the value of their taxable supplies in the previous 12 months exceeds £85,000, or is likely to do so in the next 30 days. HMRC must be advised within 30 days of the end of the month where the limit is exceeded and will then register the firm for VAT from the 1st day of the 2nd month following.

If a firm expects to exceed the limit in the next 30 days, they should inform HMRC before those 30 days expire. Registration will then be effective from the start of the 30-day period.

Once registered, a firm can then reclaim VAT on business-related purchases.

It is possible to register voluntarily with lower levels of taxable supplies.

VAT Returns

Once registered for VAT, a firm will usually need to complete a quarterly VAT return using Making Tax Digital (MTD) compatible software, listing its output tax – that is the VAT charged on sales to customers and its input tax – the amount of VAT it has paid on its purchases. If output tax exceeds input tax, the difference is payable to HMRC. Where input tax exceeds output tax, HMRC will make a repayment. If a business regularly has to reclaim VAT or if they are a large business, they will be able to submit and pay monthly. Returns and payment of tax must be submitted online by the 7th of the month following the month after the VAT period concerned.

VAT Rates

At present, there are three rates of VAT:

• the standard rate of 20% which is payable on the majority of goods and services;
• a reduced rate of 5% is payable on certain supplies, such as domestic gas and electricity and children’s car seats; and
• a zero rate is charged on certain supplies, including the installation of energy-saving materials, food, books and newspapers, public transport, and children’s clothes and shoes.

Some items are exempt from VAT altogether and these include insurance, providing credit, and membership subscriptions.

Whereas zero-rated goods or services count as taxable supplies, exempt goods do not. A business cannot register for VAT or reclaim any VAT on its purchases where it only sells exempt goods. If it sells some exempt goods or services, it may be able to reclaim the VAT on some purchases.

Flat Rate Scheme

Small businesses with a maximum annual turnover excluding VAT of £150,000 pounds can join the flat rate scheme, which enables them to account for VAT as a percentage of their turnover instead of on the difference between input and output tax.  The flat rate percentage used will depend on the sector in which the small business operates.

Limited cost traders, that is businesses that only buy a small amount of goods and services, or none at all, must use a flat rate of 16.5%.

Cash Accounting Scheme

Traders with taxable supplies of under £1.35m or less in a year can join the cash accounting scheme. This allows them to pay VAT based on the date their customers pay them rather than on the date customers are invoiced.

Margin Scheme

There is a margin scheme for dealers in second-hand goods. A lower rate of VAT is only payable on the difference between the price paid for an item and the price at which it is sold instead of the full sale price.

Bad Debt Relief

Ordinarily, VAT is accounted for on the date goods are sold or received. If a customer does not pay for their goods on time there is no immediate relief for a trader. However, once a customer bill is 6 months overdue and the debt written off, the trader can usually claim a refund of the VAT paid.

VAT and Imports

VAT is due on goods imported into Great Britain from overseas and on goods imported into Northern Ireland from outside of the EU. Exports of goods from Great Britain are zero-rated. Exports from Northern Ireland are zero-rated for countries outside of the EU.

Postponed accounting allows UK VAT-registered firms to defer the import VAT due when they import goods. The importer reports the VAT due and recoverable in their next VAT return, rather than having to pay it upfront when the goods are imported and recovering it later.

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Information in this article is correct as at 3 October 2022.