Input tax: claiming tax rebates through tax deduction

It can be difficult for en­tre­pren­eurs to keep a clear view of things when it comes to book­keep­ing and taxes. To break it down, every business is subject to sales tax, which means that you are obligated to pay taxes on your annual income. However, you also have the right to claim input tax de­duc­tions. Ul­ti­mately, this means that you don’t have to pay every penny of sales tax; consumers can alleviate some of the burden.

The terms ‘input tax’, ‘corporate tax’, and ‘sales tax’ often cause a great deal of confusion, as they are often used in tandem or even in­ter­change­ably. But what exactly are these concepts? How do you calculate input tax and what should you keep in mind when making a claim? Read on for an ex­plan­a­tion of how the input tax process works.

Output VAT is regarded as the value 1108 added tax that is cal­cu­lated and charged on the sale of goods and services from your business, if you are VAT-re­gistered. This must be cal­cu­lated on sales to other busi­nesses and to consumers. VAT paid on sales between two busi­nesses must also be specified in a sales document.

Input tax

Input VAT is the value added tax that is added to the price when you purchase goods or services that are liable to VAT. If the buyer is VAT-re­gistered, the buyer can deduct the amount of VAT paid from their set­tle­ment with the tax au­thor­it­ies.

Profit from claiming VAT

As an en­tre­pren­eur, you usually need to purchase goods, raw materials, and/or make use of services. These trading expenses might include the purchase of wares and com­mis­sioned repairs. For these kinds of expenses, VAT is paid at the normal rate (20% at the standard rate and as low as 5% at the reduced rate. There is also a 0% rated allowance for certain goods and services, e.g. most food and children’s clothes.)

By doing this, you are making a re­fund­able input tax payment but without claiming a profit. 

However, the ad­di­tion­al money spent on input tax does not go on to benefit the business who sold the goods or services. The company must then transfer the amount to the tax office at the end of the tax year. HM Revenue and Customs then claims this as cor­por­a­tion tax.

This method ensures that consumers – not companies – ul­ti­mately pay via the VAT added to products or services. The tax burden, therefore, has no influence over a company’s profits or losses.

A carpenter in Manchester needs materials in order to construct a garden shed, so she buys the raw materials from Company X. They sell her wooden panels with a total value of £1000. With the ad­di­tion­al sales tax of 20% (the average in Maine), the selling price becomes £1200 gross. If the carpenter purchases the product at the named price, Company X owes Revenue and Customs the £200 of sales tax. Company X does not make a loss because the amount was paid by the consumer during the initial trans­ac­tion process; the carpenter es­sen­tially paid the input tax.

The carpenter can now complete her shed with the parts she has acquired. The shed has a value of £2000, and with the added sales tax of 20%, the selling price has become £2400   gross. When the shed is sold, the customer pays the £400 VAT. The carpenter is then refunded the original £200   so that she no longer carries the cost of the input tax of the raw materials. All this simply means that ul­ti­mately, the carpenter only pays £200   of sales tax, rather than £400.

For another detailed ex­plan­a­tion of how to calculate input tax, check out the example given in this video:

To claim a refund on VAT, you first need to submit a VAT Return to HM Revenue and Customs (HMRC) every 3 months. This period is known as your ‘ac­count­ing period’. The VAT Return records figures for the ac­count­ing period such as:

• your total sales and purchases,
• the amount of VAT you owe,
• the amount of VAT you can reclaim,
• and what your VAT refund from HMRC amounts to.

Important: You must submit a VAT Return even if you have no VAT to pay or reclaim. As a business, you should have all of your receipts, state­ments, and invoices archived as part of your book­keep­ing measures. If you are eligible to claim de­duc­tions, you must gather these receipts and calculate the amount of VAT that you have paid during the year. To submit your return, you need to apply for a VAT number and create an online account at HM Revenue and Customs.

The majority of items purchased by business owners are de­duct­ible as long as they ex­pli­citly con­trib­ute towards op­er­a­tions and expenses. Although claims are valid for business activ­it­ies, it is permitted for these expenses to also have a personal use. However, claiming expenses for purchases that are purely for personal use is strictly pro­hib­ited. You must keep records to support your claim and show the VAT was paid.