Value Added Tax (VAT) is a consumption tax levied on most goods and services in the UK. Understanding how VAT works is essential for businesses to ensure compliance and effective financial management.

What Is VAT?

VAT is a tax added to the price of most products and services sold by VAT-registered businesses. It is ultimately borne by the final consumer but collected and remitted to HM Revenue and Customs (HMRC) by businesses at each stage of the supply chain.

Businesses are required to register for VAT if their VAT-taxable turnover exceeds £90,000 in a 12-month period. This threshold ensures that smaller businesses are not burdened with VAT administration unless they reach a significant level of sales. Businesses with turnover below this threshold can choose to register voluntarily, which may allow them to reclaim VAT on business purchases.

In the UK, there are three main VAT rates:

• Standard Rate (20%): Applied to most goods and services.
• Reduced Rate (5%): Applied to certain goods and services, such as domestic fuel and power.
• Zero Rate (0%): Applied to specific items like most food and children’s clothing.

Some goods and services are exempt from VAT or are outside the scope of the VAT system altogether.

Responsibilities of VAT-Registered Businesses

Once registered for VAT, businesses must:

• Charge VAT: Include the appropriate VAT rate in the prices of their taxable goods and services.
• Keep Records: Maintain detailed records of all sales and purchases, including the amount of VAT charged and paid.
• Submit VAT Returns: Regularly (usually quarterly) submit VAT returns to HMRC, detailing the VAT collected and the VAT paid on business purchases.
• Pay VAT: Remit any VAT owed to HMRC after accounting for VAT paid on purchases (input tax) against VAT collected on sales (output tax).

If a business has paid more VAT on purchases than it has collected on sales, it can usually reclaim the difference from HMRC.

To simplify VAT accounting, HMRC offers various schemes, such as:

• Flat Rate Scheme: Allows businesses with a turnover of less than £150,000 to pay a fixed percentage of their turnover as VAT, reducing the complexity of record-keeping.
• Cash Accounting Scheme: Businesses pay VAT on sales when they receive payment and reclaim VAT on purchases when they pay their suppliers, aiding cash flow management.
• Annual Accounting Scheme: Businesses make advance VAT payments throughout the year and submit a single annual VAT return.

Each scheme has eligibility criteria and potential benefits, so businesses should assess which, if any, align with their operations.