In last month’s article, we introduced VAT and mentioned that if your business is registered for VAT, then it has to charge VAT on all the taxable sales it makes to all its customers. This VAT is called “output VAT”.
It will also be able to reclaim some, but not all, of the VAT that its suppliers charge if it is registered for VAT. There are some supplies on which VAT can’t be reclaimed, and we’ll look at that in a moment. VAT that can be reclaimed is called “input VAT”.
The VAT that your business will actually pay to HMRC each quarter is its output VAT less its input VAT. If input VAT for that quarter is greater than output VAT then HMRC will refund the difference to your business.
But what output VAT should you charge, and what input VAT can you reclaim?
Output VAT: taxable sales
When you’re VAT-registered, you have to charge output VAT to all your customers at the right rate for that sale.
It doesn’t matter if the customer is VAT-registered or not, you still have to charge them VAT if the sale is taxable.
There are three different rates of VAT operating in the UK: 20% (standard), 5% (reduced) and 0% (zero). Zero-rated sales are still taxable and still subject to VAT, but the rate of VAT on them is 0%.
Most sales of goods and services in the UK are standard-rated.
The reduced rate applies most often to goods that are “quasi-essential” - that is, you could manage without them if you had to but it would be difficult. These include, for example, electricity and gas for domestic use.
Zero-rating applies to goods and services such as equipment for the blind and the disabled, passenger transport by bus, and books, magazines and newspapers - though e-books are standard-rated.
There are a lot of rules that determine the rating of a particular service or type of goods, down to the smallest detail. For example, gingerbread men decorated with chocolate are standard-rated, unless the chocolate decoration “amounts to no more than a couple of dots for eyes”, in which case the gingerbread man would be zero-rated.
If you’re in any doubt have a look at http://www.hmrc.gov.uk/vat/forms-rates/rates/goods-services.htm which lists the more common types of goods and services that are reduced-rated or zero-rated.
You do need to know which rate applies to everything you buy or sell, before you enter it into your accounting system. There is help at hand though - more on that at the end of this article.
Output VAT: non-taxable sales
And we haven’t finished yet.
There are some goods and services which are exempt from VAT. That means no VAT is charged on them at all, which is different legally from zero-rated VAT where VAT is charged but at 0%.
The sale of postage stamps is exempt from VAT, as is burial of the dead.
And there are also some services and goods which are outside the scope of VAT altogether. This includes, for example, bridge and tunnel tolls which are operated by public authorities. If these are operated by a private company they’ll be standard-rated.
Both exempt sales and out-of-scope sales are non-taxable sales. So when you’re checking to see if you should register for VAT, don’t count these sales.
Whether or not you’re actually registered for VAT yourself, if you buy taxable goods and services from suppliers who are registered, you will pay VAT as part of what you pay to the supplier.
If your business is registered for VAT, as a rule of thumb you can then claim back this VAT.
But there are several catches.
There are some goods and services on which you’ll pay VAT to your suppliers but you can’t claim it back from HMRC. Business entertaining is the classic example of this. If you entertain anyone other than your own staff, HMRC say that the input tax on this is “blocked”, which means that you can’t reclaim it.
You also can’t reclaim input VAT if you don’t have a valid VAT invoice or valid simplified VAT invoice (such as a till receipt) from your supplier.
Also, if your business makes a lot of exempt sales, you may be restricted in the amount of input VAT you can claim.
If your business only makes exempt sales, you’re actually not allowed to register it for VAT.
If your business makes a mixture of exempt and taxable sales, then you can register, but you’ll only be able to reclaim the amount of input VAT that you incur on the taxable sales. This is called partial exemption.
The calculations for this do get quite complicated because there will be some input VAT that relates to both types of sales, such as accountants’ fees.
Even when you know when to charge output VAT and when to reclaim input VAT, there are still questions to ask about how you should add up your VAT return and what you’ll actually pay to HMRC.
We’ll look at that in the next article.
Where can I get help?
VAT can be very daunting but there is help available for business owners!
Using an accounting system like FreeAgent will set you on the right path because it has an “Auto” VAT setting for each category of goods or services you buy, which gives you at least a 50% chance of getting your VAT right. It also helps you create VAT invoices which comply with HMRC’s rules, to give your customers.
HMRC’s website has a comprehensive VAT area as well, which can help you identify when you can and can’t claim input VAT, and how you should charge output VAT. You should also consider seeking advice from an accountant if you have any queries about any specific VAT issues.