Overview of VAT

What is VAT?

VAT is a sales tax charged by business on certain goods and services they provide. When a business is subject to VAT it is added to their invoices, which is then paid to HMRC.

In addition, the business can deduct the VAT they have pain in making their vatable sales from the payment to HMRC, i.e. only the net VAT amount is paid to HMRC.

VAT Related Terminology

The following terms are used in relation to VAT:

Term

DESCRIPTION

Input VAT

VAT on purchases made for incoming goods/services.

Input VAT can only be recovered where:

  • it has been correctly charged.
  • the supply has been made to the organisation.
  • the required evidence is retained (e.g. the invoice).

Output VAT

VAT on sales made for outgoing goods/services.

Output VAT can only be charged by an organisation if they are registered for VAT.

Standard Rate

The standard rate of output VAT is 20%. Input VAT is recoverable on purchases that include the standard rate of VAT, such as computers and office equipment.

Reduced Rate

The reduced rate of output VAT is chargeable at 5%. Input VAT is recoverable on purchases that include the reduced rate of VAT, such as energy saving materials and domestic fuel.

Zero Rate

Zero rated suppliers are taxable but at a rate of 0%. This means VAT is not charged to the customer, but the VAT incurred in making the supply can be recovered. Examples include books, children’s clothing and footwear, certain foods, etc.

Exempt

No VAT is chargeable, but equally, no VAT can be claimed.

Outside the scope

No output or input VAT is payable under any circumstance.

A transaction is outside the scope if it is:

  • made by someone who is not a taxable person.
  • not made in the course or furtherance of business.
  • potentially subject to other taxes.

For example: Wages payments and fees fixed by law (congestion charge, MOT, etc).

Recovering VAT

The procedure by which a VAT registered organisation can recover the VAT it incurs on purchases that are used to make taxable supplies.

Reclaiming VAT

The procedure by which an organisation can obtain a refund for the VAT it incurs on purchase that are used in its non-business activities. Both VAT registered and unregistered organisations can obtain VAT refunds under the scheme.

Directly Attributable

VAT on a purchase is directly attributable to an activity type (taxable, exempt or non-business) if the purchase is used wholly in that type of activity.

Residual VAT

VAT on a purchase is residual if it is to be used for different activity types. Typically, where there is mix of different types of activity, VAT on overheads will be residual.

De-minimis

A VAT registered business cannot normally recover the VAT it incurs in its exempt activities. However, if the overall level of exempt activity is very small, both in absolute terms and in comparison, to the level of taxable activity, then the VAT incurred in exempt activities can be recovered. In this situation the exempt activity is said to be ‘de-minimis’.

What Costs can be Reclaimed?

The costs that can be reclaimed depend on whether the establishment / organisation is VAT registered and what business activities (if any) are carried out.

Understanding how Activities are Classified for VAT

For the purposes of VAT, it is important to understand how activities are classified. There is no prescribed method, and your establishment/organisation may use a different approach. The following description provides a typical example.

Business Activities - for VAT purposes, business means any continuing activity/supply which is 'in the course of furtherance of business'. These can include charitable and not for profit activities. There are two key considerations:

  • Whether the activity mainly involves the making of supplies for a charge.

  • Whether a supply of goods or services is made which is comparable with, and/or in competition with, supplies made by the private sector.

Taxable Business Activities - all business activities, except those that are exempt or non-business are taxable supplies. If you are registered for VAT, then all the taxable business transactions that are liable for VAT are called taxable supplies. They are either standard rated, lower rated, or zero rated.

Exempt Business Activities - are business transactions that are outside the scope of the UK VAT system therefore VAT is not chargeable at either the standard or zero rates.

Non-Business Activities (outside the scope) - These are activities that do not fall under the business definition, are made by someone who is not a taxable person, and are not made in the course of furtherance of business. For example, an establishment/organisation providing free advice to its members.