VAT becomes a key concern as your business grows. You’ll need to register for VAT when your turnover exceeds the threshold, and you’ll need to carry out VAT accounting.
But VAT can be confusing, especially as there are different rates that can be charged. Here, we explain what VAT rate you should charge, along with the basics of the VAT flat rate scheme.
- VAT MOSS explained: a guide for small businesses
- VAT registration – is it right for my business?
- What are your tax responsibilities as a start-up business?
- How much business insurance do I need?
What is VAT?
Value Added Tax, or VAT, is a tax levied on the purchase of taxable goods and services. Businesses might pay VAT on goods and services that they buy, and they might charge it on goods or services that they sell.
VAT is charged at a number of different rates, depending on the nature of the item. If your business is VAT registered, it’s important that you’re charging the right rate of VAT.
What are the different VAT rates?
There are three different VAT rates.
- the standard rate is charged at 20 per cent
- the reduced rate is charged at five per cent
- the zero rate is charged at zero per cent
It’s important to understand that ‘zero rated’ items are not the same as ‘exempt’ items. Things like postage stamps, financial transactions, and sports activities are exempt from VAT. However, most food and children’s clothes are zero rated.
So even though there’s no VAT on zero rated supplies, it’s still a rate of tax. This means you can reclaim your input VAT, for instance your costs and overheads when producing the zero rated goods.
Exempt means the goods or services are outside the VAT system. If you only make exempt goods, you can’t register for VAT and reclaim VAT.
How much VAT should I charge?
It can be confusing to work out which VAT rate you should charge in different circumstances. If you’re VAT registered, you have to charge VAT on all relevant transactions. However, you can also claim VAT back on purchases that you make.
Most VATable transactions will be charged at the standard rate of 20 per cent (note that this increased from 17.5 per cent in 2011). Most businesses will generally deal only with the standard rate.
However, depending on the nature of your business, you may sometimes need to charge different rates. For example, if you’re selling children’s car seats, or if your business deals in home energy, you’ll be charging the reduced rate of five per cent.
As for food and drink, the goods you sell are usually zero rated, but some items like alcohol and confectionary are always standard rated.
Because there’s an extensive range of rates that differ depending on the goods or service, it’s important to understand which ones apply to you and your business. There’s lots of guidance on VAT rates on the .gov website. There, you can find information about all of the different rates, and the circumstances in which they will be charged.
What is the VAT flat rate scheme?
Many smaller businesses choose to enrol in the VAT flat rate scheme. Under this scheme, you pay a fixed amount of VAT to HMRC, and then keep the difference between the VAT you charge to customers and the VAT you pay to the taxman. However, you generally can’t reclaim VAT paid on your purchases – although there are some exemptions for capital expenditure over £2,000.
The VAT flat rate scheme is popular amongst smaller firms that want a simple way of accounting for VAT. It’s only open to businesses with a turnover below £150,000.
However, it’s important to understand that even if you are enrolled in the VAT flat rate scheme, you will still need to charge the correct rates of VAT as explained earlier in this article. If you think the flat rate scheme might be right for you, you should speak to your accountant.