Let’s say you’ve just launched your own business and things are picking up—until you see “VAT” popping up on your bills and receipts. At first, it’s just another line item, but soon you realize it’s affecting your prices, your invoices, and even how much tax you owe. It’s easy to feel overwhelmed or make mistakes that cost you money. That’s why it’s so important to understand what VAT actually is and how it works from the start.
What is VAT?
A value-added tax (VAT) is a consumption tax that is imposed on the value added at each stage of a good or service’s production. It is not a tariff. Every business in the supply chain acquires tax credits for the VAT they have already paid. The end consumer does not, hence it is a tax on final consumption.
VAT-registered businesses have to register if their VAT taxable turnover is more than £90,000 (as of 1st April 2008) in a year. Knowing terms like input VAT and output VAT also helps when it comes to doing your tax returns.
Calculating VAT for invoices or purchases? ➔ See how to track Input and Output VAT step-by-step!
What Are the VAT Rules in the UK?
- Add the right amount of VAT to the price of all goods and services.
- Keep track of how much VAT you pay on business purchases.
- Pay VAT on any products you bring into the UK
- Send a VAT return to HM Revenue and Customs (HMRC) every three months to tell them how much VAT you charged your customers and how much VAT you paid to other businesses.
- You should also pay any VAT you owe to HMRC.
Your VAT is usually the difference between the VAT you charged your clients and the VAT you paid to other firms.
You have to pay the difference to HMRC if you charged more VAT than you paid.
VAT was introduced by the Finance Act 1972 and first came into effect on 1 April 1973 at 10%. It is now at 20%.
— James Melville 🚜 (@JamesMelville) May 17, 2024
It’s an appalling stealth tax that hammers small businesses, the poor and millions of people facing a cost of living crisis.
There is an ongoing cost of living… pic.twitter.com/iEJrL4iCNF
If you charged more VAT than you paid, HM Revenue and Customs (HMRC) will normally give you back the difference.
If you choose, you can hire an agent to talk to HMRC for you.
You can join VAT schemes that change how you figure out and submit the VAT you owe HMRC.
How Does VAT Work in the UK?
Every business that is registered in the UK for VAT gets a VAT number. They need to give clients a bill that shows how much VAT they charged. So, the customer understands how much VAT they owe. If they are a registered trader, they can then take this sum off the VAT they collected and provide the rest to tax authorities such as HM Revenue & Customs or the Federal Central Tax Office.
This method avoids double taxation by solely taxing the value added at each step of production and distribution. The total amount of VAT paid is the sum of the VAT paid at each step.
Example
For €240, an iron mine buys helmets that cost €200 plus 20% VAT. After that, the mine sells iron ore to a smelter. The ore costs €1,000, and the VAT rate is 20%; thus, the smelter pays the mine €1,200. The mine then takes the €40 VAT it paid out of the €200 VAT it collected and sends the treasury €160. The treasury has now successfully collected €200 in VAT, having received €40 from the helmet seller and €160 from the mine.