This post was originally published on this site.
VAT is an ever-present headache for small business owners. They’re often left wondering how much they should be charging or whether they even should be charging it at all.
Luckily for you, this article explains the rules of VAT and how you should be calculating it.
Rules of UK VAT
VAT is added to most products sold by VAT-registered businesses in the UK. This covers:
- Goods or services
- Hiring or loaning goods to someone
- Selling business assets
- Commission
- Items sold to staff, such as canteen meals
- Business goods used for personal reasons
- Non-sales, such as bartering, part-exchange and gifts
Exempt goods and services include:
- Education and training
- Financial services, investments and insurance
- Healthcare and medical treatment
- Funeral plans, burial or cremations
- Charity events
- Antiques
Charity donations, goods bought outside the UK, statutory fees and goods you sell as part of a hobby (e.g. stamp collection) are seen as ‘out of scope’ so won’t need a VAT charge.
You must register for VAT if your turnover is more than £90,000 per year to adhere to Making Tax Digital. Keep records of VAT on things you buy for your business and make sure you account for VAT on any goods you import into the UK.
Send a VAT return to HMRC every three months.
Normally, the VAT you pay is the difference between any VAT you’ve paid to other businesses and the VAT you charge to customers. If you’ve charged more than you have paid, you must pay the difference to HMRC. If you’ve paid more than you’ve charged, then HMRC will normally cover the difference.
The standard 20% VAT rate doesn’t apply to everything you sell. Some items are reduced VAT (fuel, certain health products, car seats for children) while others are zero-rated VAT – unprocessed human food and drink, for the most part, is zero-rated.
How to add VAT to net price
Your net price is another way of saying the price of the item. When adding VAT, you can just add 20% if it’s a standard VAT item; 5% if it’s a reduced VAT item; and 0% if no VAT applies.
Calculating VAT backwards
A calculator will be handy here. Take the total amount and divide it by 1 plus the VAT percentage. So, if the VAT is 20%, divide it by 1.20. That means that a £200 item divided by 1.20 is £166.67. If you take away £166.67 from 200, that leaves you £33.33, which gives you the VAT.
How VAT is paid
VAT is paid through your VAT return every three months. This is a form which tells HMRC how much VAT you’ve paid and how much you’ve charged. Even if you have no VAT to pay or reclaim, you still need to file a VAT return. If you’re using software, your provider will give you guidance on how to file your return. If you’re exempt from keeping digital records, you do your return online. If you can’t do that, HMRC will provide an alternative.
Paying VAT under the flat rate scheme
What if you pay a fixed rate of VAT to HMRC under the flat rate scheme? You keep the difference between what you charge and what you pay to HMRC. You can’t reclaim the VAT on purchases, except for certain capital assets that are over £2,000.
The flat rate you pay is depends on the type of business you run – find out more here. Calculate the tax you pay by multiplying your VAT flat rate by your ‘VAT inclusive turnover’.
Advice from the accountants
Small Business asked for some sage wisdom from UK accountants, avoiding the mistakes that small business owners frequently make.
Chartered accountant, Nicole Zalys, from The London Accountant:
- Good record-keeping is one of the most important foundations for getting VAT right and businesses should make sure invoices clearly show the net amount, VAT rate, VAT charged and total amount, and regularly check that the figures recorded in their accounting software match the original invoices and receipts.
- Getting into good habits throughout the accounting period is far more effective than trying to identify discrepancies when a VAT return is due.
- Depending on what is being supplied, something may be standard-rated, reduced-rated, zero-rated or exempt, so it’s important to establish the correct VAT treatment rather than make assumptions based on similar transactions.
- Accounting software can significantly reduce basic calculation and administrative errors, but it shouldn’t replace an understanding of the figures. Business owners should review their VAT records regularly and investigate anything that doesn’t look right rather than relying entirely on the software or waiting until the return deadline.
- VAT can become considerably more complicated when a business is dealing with unusual transactions or overseas customers and suppliers. If there is any uncertainty about the correct treatment, getting professional advice at the outset can be much easier, and less costly, than trying to correct a VAT mistake further down the line.
Jane Stacey, VAT partner at Xeinadin, said:
- VAT mistakes are particularly easy for SMEs to make because the person doing the VAT return is often wearing several hats, also managing payroll, invoices, suppliers and cashflow. Mistakes can therefore sit unnoticed and repeat themselves across a longer period.
- Reclaiming VAT can create similar problems. An owner-managed business might pay for a phone, a car or other cost with both business and personal use. The VAT position needs to reflect how that expense is used, supported by proper records. There are also certain costs which are blocked from recovery, such as business entertainment.
- SMEs also need to take care regarding the information going into their accounting software. An incorrect VAT code or incomplete invoice can be repeated hundreds of times before anyone notices. Regular checks are far easier than correcting a quarter’s worth of transactions later. Errors may lead to interest and penalties.
- HMRC’s Transformation Roadmap makes those processes increasingly important. VAT administration changes are being rolled out through 2026 and 2027, with mandatory e-invoicing for business-to-business and business-to-government transactions due from April 2029. SMEs should use that time to review their systems, VAT coding, invoice approvals and customer and supplier data.
- My advice to small businesses is to keep VAT records up to date and raise questions as they happen. For one-off or non-core transactions, such as selling an asset, professional advice should be taken.
