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The Basics of VAT
VAT can be complex. For some transactions and businesses, it is straight forward, whilst for others it can be complicated. There are VAT codes, VAT schemes, and decisions to make about whether VAT is included in a transaction and if there is, can it be claimed?
VAT registered businesses will charge VAT on most services and goods they sell. This VAT has to be paid over to HMRC. However, a business can usually deduct VAT they are charged, from the VAT collected.
A VAT return is made electronically to HMRC which declares the amount due (VAT on sales less VAT on purchases). Payment must follow either by making an online payment or signing up for direct debit. Businesses signing up for direct debit get an extra few days before the money is collected.
VAT return frequencies
The most common frequency is quarterly but sometimes returns can be monthly or annually.
Monthly schemes have to be applied for and are usually for businesses who receive regular refunds. This would usually be for businesses who are able to claim VAT on purchases but have little or no sales which attract VAT, or operate in the construction industry and are subject to the Domestic Reverse Charge.
The annual scheme has to be applied for and helps businesses plan their cashflow. See VAT schemes below for further details.
VAT Registration
When your Vatable sales reach a certain threshold, you must register for VAT. The threshold can change each year and the basis is a rolling twelve months. A business needs to monitor the sales every month and register within 30 days of reaching the threshold. A business can also choose to register before reaching the threshold.
VAT Schemes
There are numerous VAT schemes, some are compulsory and some are optional.
The simplest and most used schemes are as follows:
- Standard scheme (sometimes called the Accrual scheme)
- Cash accounting
- Flat Rate Scheme
- Annual accounting Scheme
- Other schemes
- Second hand scheme (Usually cars and antiques)
- Domestic Reverse Charge (Construction)
- TOMS (for the travel industry)
- Partial Exemption (when some of your sales are exempt from VAT, see below)
- Retail Schemes (for retailers)
Choosing a VAT scheme
For most businesses, you are able to choose between the standard scheme, cash accounting, flat rate and annual, however, all these except the standard scheme are subject to upper limits.
Standard VAT Scheme
VAT is declared on sales, less VAT on purchases. This is regardless of whether the invoices are paid.
Cash Accounting scheme
VAT is declared on sales only when paid, less VAT charged on paid purchases. This scheme is not always advantageous to a business and depends on credit terms provided and received. You do not need to apply to use the cash accounting scheme but businesses with a turnover of £1.35m (Dec 23) cannot use this scheme.
Annual Accounting VAT scheme
This scheme has to be applied for. The principle of sales VAT less purchase VAT, is the same as the standard scheme but the payments work in a similar way to an energy supplier’s budget scheme. A fixed amount is paid to HMRC every month or every quarter. A return is submitted at the end of the year, similar to providing a meter reading, and the business has two months to either reclaim if they’ve paid too much or make an additional payment if they’ve not paid enough. With modern software, it is easy to keep an eye on whether the business is over or under paying throughout the year. This scheme can provide an excellent cashflow advantage for businesses as long as it is managed carefully. Businesses with a turnover of £1.35m (Dec 23) cannot use the scheme.
Flat rate scheme
This scheme has to be applied for. Businesses raise sales invoices plus VAT at the standard rate but they only have to pay a proportion of the VAT to HMRC – this rate is dependent upon the business sector. VAT on purchases cannot be claimed, unless a fixed asset costing more than £2,000 is purchased. Only businesses with a turnover of less than £150,000 (Dec 23) per year can use this scheme, and if the cost of goods sold figure is very low, the business may be considered a “Limited cost business”. They could be worse off and should consider using the standard or cash accounting scheme. See here for further guidance and a calculator to help decide if you are a limited cost business.
VAT Rates
Goods and services are categorised for VAT purposes. They are firstly divided into “Within the scope of VAT” or “Outside the scope of VAT”.
Outside the scope of VAT
These include:-
- Loans made and received
- Finance
- Wages and Salaries
- Taxes, including VAT, PAYE, Corporation Tax
- Dividend payments
- Pension payments
- Goods or services you buy or use from outside of the EU
- Journals moving balances between different nominal codes
The above transactions should not be included in a VAT return.
Within the scope of VAT
Current rates include:-
- 20% Standard
- 5% reduced rate
- 0% zero rated
- 0% exempt
Transactions with the above rates should be included in a VAT return.
Zero Rated and Exempt VAT
There is sometimes confusion around the difference between zero rated and exempt. Unless the business sells goods or services at either of these rates, there is no need to identify the difference.
Exempt
Businesses selling exempt services or goods, will not need to register for VAT as they are not considered Vatable. They cannot claim any VAT on purchases.
Common exempt supplies include:-
- Sporting activities
- Childcare
- Insurance
- Health Services provided by Doctors
- Postage stamps
Zero Rated
These goods or services are VATable at 0%. Businesses charge 0% on their sales invoices and are able to claim back VAT charged on purchases.
Zero rated supplies include:-
- Books and newspapers including some printing
- Motorbike helmets
- Children’s clothes and shoes
Partial exemption
If a business sells exempt goods or services and also sells Vatable goods or services, they may have to operate “Partial exemption” if the value of the Vatable sales reaches the current VAT threshold. This involves calculations to attribute VAT charged on purchases to either the exempt sales or the Vatable sales; making adjustments to VAT charged on purchases for both; and checks against de minimus rules, before a return can be made.
VAT Codes
Software uses codes, descriptions or both to distinguish between different rates of VAT and whether the transaction will be included in a VAT return. Additional VAT codes sometimes have to be created by the user to account for special schemes such as partial exemption or the second hand scheme.
When VAT is included, when to charge VAT, and when to claim
Sales
Most businesses will charge a standard 20% on all their goods and services, however, as detailed above, some goods, services or industries have special rules. Professional advice may be needed in these cases.
Purchases
There are some general rules around when VAT can or can’t be claimed.
- Leased cars – 50% of the VAT charged can be claimed. Enter the invoice over two lines and divide the gross (the amount including VAT) by two. Enter the first line using a VAT code which will not account for VAT. Enter the second line using a VAT code which will calculate the rate at 20%.
- Entertainment – VAT cannot be claimed on any client entertainment. So although there is likely VAT on the receipt, the business cannot claim it. VAT cannot be claimed for any staff members present. If a client is involved, no VAT can be claimed. Use a VAT code which will not split the VAT.
- Staff entertainment – VAT can be claimed on staff entertainment for a limit number of events with a per head annual limit.
- Subsistence – VAT can be claimed on food, drinks and accommodation for staff working away from their usual place of business. VAT can even be claimed for end of month staff drinks. However, this does not include buying sandwiches from the shop next door for the office every day. If there is doubt as to whether VAT can be claimed, use a VAT code that will not split out the VAT.
- Food and drink – Some food and drinks are classed as luxury and others are classed as essential. This definite which VAT rate applies when bought from a shop or retailer. Essential items that will not carry VAT include:- -milk, coffee and tea, sugar, flour, plain biscuits, sandwiches. Any food or drink consumed on premise is Vatable and if the above ingredients are used to make another product such as a cake, it may no longer be “essential”. Take away hot foot and drinks are Vatable.
VAT evidence
In order to claim VAT, we must have the correct paperwork to support it. This should be in the form of an invoice (sometimes known as a bill) or a receipt (sometimes known as an expense).
An invoice, or bill, will generally show the net, VAT, and gross figures separately.
Retail receipts, however, may not show the VAT split. You need to assess two things:-
- Is the retailer VAT registered and is their VAT registration number visible?
- Are the goods/services purchases within the scope of VAT, and at which rate?
If the VAT registration number is visible and the total value is under £250, you can calculate the VAT by dividing the total by 6 (for 20% VAT). If some of the goods or services listed are exempt or zero rated, there should be a indication to this effect on the receipt. For example, some items may have an asterix next to the them to indicate they are exempt.
VAT rates and software terminology
The most common rates are as follows and some software use different codes for income and expenditure at the same rate:-
| Xero | Sage | QuickBooks Online |
| 20% VAT on income | T1 | 20% S |
| 20% VAT on expenditure | T1 | 20% S |
| Exempt expenses | T0 | Exempt |
| Exempt income | T0 | Exempt |
| No VAT | T9 | No VAT (0%) |
| VAT on imports | T1 | 20% S |
| Zero rated | T2 | 0.0% Z |
Useful notes on VAT codes
Exempt Income and Expense codes will not show a VAT value but the net value of the transaction will be included in VAT returns. These codes are used for non-VAT registered supplier invoices and goods charged at 0% VAT.
“No VAT” or T9 will not show a VAT value and the net values will not appear on a VAT Return. These codes are used for wages, salaries, tax payments (PAYE; VAT; Corporation Tax etc), loan repayments and most journals.
“VAT on imports” (Xero) is used where there is a large amount of VAT on an invoice (greater than the net) or a VAT only invoice.
