VAT is a tax charged on goods and services in the European Union, including the UK. If a product or service has VAT charged to it, it should be included on the price ad­vert­ised. It was in­tro­duced in the UK in 1973, and is an important source of income for the gov­ern­ment, collected by HMRC. The level of VAT can change, and was increased to 20% in 2011 – and has remained at 20% ever since.

VAT is con­sidered to be an indirect tax, because in­di­vidu­al consumers do not have to pay VAT in their tax de­clar­a­tions, but rather it is collected by the business selling the goods or services, and paid to HMRC via the business. In this article we will look at further details of what VAT is, who needs to charge it, and how to calculate it.

VAT – an important source of income for the gov­ern­ment

VAT is one of the most important taxes for the gov­ern­ment – after income tax and national insurance, it is the largest source of revenue for the gov­ern­ment. It is estimated that the UK lost £1.5bn in 2017 alone, just through overseas online retailers not paying VAT in the UK. The total VAT tax gap was £12.2bn in 2015-16, meaning that although VAT is already an important source of income for the gov­ern­ment, it could be much higher without these gaps.

When is VAT charged?

Business earning over £85,000 must register for VAT, and complete a VAT return every quarter. You should register for VAT if your annual turnover exceeds the threshold, which is currently £85,000, or if you think it will soon exceed this. The threshold for VAT may change up to once a year. This happens when the gov­ern­ment announces the budget for the upcoming tax year, and therefore this happens at the end of the current tax year – in the spring around March or April. Make sure you check this yearly to avoid com­plic­a­tions!

If you add VAT to invoices, make sure you list the VAT amount sep­ar­ately, so that the cost of the products or services sold before VAT can be seen before the final total, with VAT added. This way customers can see what they paid for the service or goods pre-tax. Check out this article on VAT numbers for detailed advice on who needs a VAT number, and how to apply for one.

Tip

Once you’re a VAT re­gistered business, selling to other VAT re­gistered busi­nesses is a breeze. It’s easy to add the VAT to your invoice for these trans­ac­tions, because the business you’re selling to can just reclaim the VAT they have paid already. It becomes slightly more com­plic­ated when selling to in­di­vidu­al customers. This is because they cannot reclaim VAT, and would es­sen­tially be paying 20% more if you add VAT to their invoices. If you think your customers will not pay 20% extra, you may have to find a com­prom­ise. Reducing your own profit margins by limiting the price increase to 5%, for example, means that you’re less likely to lose customers, and can increase your prices slowly and steadily to regain the same margin.

Different VAT rates – which products are charged when?

There are currently three rates of VAT in the UK: standard at 20%, reduced at 15%, and zero at 0%. The reduced rates apply to goods such as domestic fuel, and the zero rate to most food and children’s clothing – there is a table below with more detailed examples. The table is by no means a complete list – it is just to give an overview of the range of different products and services that fall into each category. Fur­ther­more, it shows how specific some of these reg­u­la­tions are, as well as how general – because of this, it is always a good idea to speak to a tax advisor when deciding which category your product or service falls into for value added tax charges.

Standard rated Alcoholic drinks Chocolate covered biscuits Bottled water Elec­tri­city, gas, heating oil & solid fuel for a business Delivery charges Privately operated bridge, tunnel, and road tolls Hot take-away food & drinks Postal services
Reduced rated Maternity pads Mobility aids for the elderly Sanitary pro­tec­tion products Energy saving materials – only when installed per­man­ently in res­id­en­tial or charity premises
Zero rated Equipment for disabled people Public transport fares Pre­scrip­tion medicine Eggs Tea, coffee & cocoa
Exempt TV licence Funeral plan insurance Medical treatment & care Gambling

As we can see, the table shows that some defin­i­tions are very broad, such as ‘medical treatment and care’, and others quite specific, such as only chocolate covered biscuits being charged the full VAT rate. Fur­ther­more, this table also shows some instances of when not to charge VAT. The full list can be found at the HMRC website, which shows the VAT rates on different goods and services.

How to calculate VAT

Cal­cu­lat­ing valued added tax is simple. A pocket cal­cu­lat­or is all you’ll need. Al­tern­at­ively, there are many programs on the internet that make the process easier for you. There are two cal­cu­la­tions you may wish to make – VAT-inclusive prices, and/or VAT-exclusive prices.

VAT-inclusive

To work out the price of something you want to sell including the standard VAT rate, all you have to do is multiply the product or service price by 1.2. For the reduced rate (5%) the mul­ti­plic­a­tion is 1.05.

For example:

  1. You sell an alcoholic beverage for £10 , so now multiply this by 2
  2. The cal­cu­la­tion is: 10 x 1.2= 1 The total you should charge including VAT is £1

VAT-exclusive

To work out the price of something without the VAT rate, simple do the opposite of the cal­cu­la­tion above – divide the total by 1.2 for the standard rate, or by 1.05 for the reduced rate. You have your pre-tax amount!

For example:

  1. You sell an alcoholic beverage for £12, and need to know the pre-VAT amount.
  2. The cal­cu­la­tion is 12/1.2 = 10. £10 is the pre-tax amount.

Please note the legal dis­claim­er relating to this article.

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