Everything you need to know about VAT if you are running a business

At DSR Tax Claims Ltd, we know that setting up a business is hard work, especially when you have to deal with the financial and tax side of business. That’s why our experts want to help make life as easy as possible for you by sharing our specialist knowledge with you. So, whether you are wanting more information about VAT or need to know how to register as a limited company, our handy guides are here to help. All our information is based on HMRC sources, so you can rest assured that these guides are filled with helpful and accurate information.

What is VAT?

VAT – Value Added Tax – is a tax on purchases of certain goods and services or ‘taxable supplies’. VAT doesn’t apply to all goods and services – some are exempt from the tax (such as most food and children’s clothes as well as advertising services for charities) and some have a reduced rate of 5% (such as children’s car seats, mobility aids for the disabled and home energy). The standard rate of VAT is 20% and is applicable to most goods and services.

How does VAT work?

VAT is charged on various goods and services (known as ‘taxable supplies’), such as:

  • Business sales – selling goods or services, for example.
  • Selling business assets
  • Commission
  • Items sold to staff, such as canteen meals
  • Hiring or loaning goods to someone
  • Business goods when used for non-business reasons
  • Forms of non-monetary exchange, such as bartering, part-exchanging or giving as a gift.

Your business can only charge VAT If it is registered for VAT.

What are the responsibilities of VAT-registered businesses?

Businesses which are registered for VAT have certain responsibilities. The VAT-registered business must charge VAT on their goods and services and they may be able to claim back any VAT that they have paid on business-related goods and services.

VAT-registered businesses are required to report to HMRC the amount of VAT they have charged and the amount they have paid, via a VAT return (usually completed every 3 months). Businesses may appoint an agent to deal with the VAT for HMRC on their behalf if they so wish.

If your business is registered for VAT, you must account for VAT on the full value of what you sell, even if you receive goods or services instead of money (for example, you take something in part-exchange for goods that you sell) or you haven’t charged any VAT to the customer – whatever the price you sell your goods and services at, HMRC will treat that as including VAT.

If you have charged more VAT than you have paid, you will be required to pay any difference to HMRC but if you have paid more VAT than you have charged, you can reclaim that difference from HMRC.

What are the different rates of VAT?

There are 3 different rates of VAT and it is the responsibility of the business to ensure they are charging the right amount for the goods or services they provide.

Standard VAT rate

Most goods and services are charged at the standard rate of 20%. This is the rate you should use unless your goods and services are classed as reduced or zero rate.

Standard-rate goods and services include:

  • Most services your business might provide to an EU non-business customer (there are different rules for business customers)
  • Any goods below the ‘distance-selling threshold’ that you supply to non-VAT registered EU customers. If your business goes over that threshold, you will be required to register for VAT in that country.

Reduced VAT rate

Charging the reduced rate of 5% not only depends on the goods or service that you are selling, but other circumstances may also apply. For example, children’s car seats are always charged at the reduced rate of 5% but mobility aids for older people are only chargeable at 5% if they are for someone over the age of 60 and the goods are installed in their home, otherwise the standard rate of 20% is chargeable.

Zero VAT rate

Certain goods and services are classed as zero VAT rate – this means that they are still VAT-taxable but the rate you charge your customers must be 0%. However, these sales will still need to be recorded in your VAT accounts and reported in your VAT return.

Zero VAT rate goods include:

  • Children’s clothing and footwear
  • Motorcycle helmets
  • Books and newspapers

This VAT category also includes most goods that you export to non-EU customers as well as goods that you may supply to a VAT registered EU business (although you need to check that their VAT number is valid). If you are sending goods to the EU, you will need their VAT number and you will also need paperwork to prove that the goods have been sent within specified time limits (usually 3 months)

It is important to note that VAT rates can change and you will need to apply the changed rates from the date that they change.

What do you need to do if you charge VAT to your customers?

Firstly, it is very important to know the correct VAT rate so that it can be charged accurately and you can reclaim it on your purchases.

For all transactions, whether standard, reduced or zero rated, you must ensure that you do the following:

  • You must charge the correct rate of VAT
  • You need to work out the VAT if only a single price is shown (and separate, or mark your prices including or excluding VAT)
  • You must show the VAT information on your invoice
  • You must show the transaction in your VAT account (this is a summary of your VAT transactions)
  • You must show the amount on your VAT return.

You might be able to reclaim the VAT on purchases made for your business. However, if the purchase is for personal as well as business use, you will only be able to reclaim the business proportion of the VAT.

You can’t claim back all the VAT you have paid if you pay the wrong amount of VAT on a purchase.

What are VAT-inclusive and VAT-exclusive prices?

To claim back the VAT you have paid on items, which were sold inclusive of VAT, or to work out how much VAT to charge on your goods or services, you will need to know how to calculate VAT.

VAT-inclusive prices: If you want to work out a price, which is inclusive of the standard rate of VAT (20%), you need to multiply the VAT-exclusive price by 1.2. If you are using the reduced rate of VAT in your calculations, you need to multiply the VAT-exclusive price by 1.05.

For example, if you have a product with a VAT exclusive price of £25, to calculate the price inclusive of standard-rate VAT, the calculation would go: £25 x 1.2 = £30. If it was reduced rate it would be: £25 x 1.05 = £26.25

VAT-exclusive prices: If you want to work out a price excluding the standard rate of VAT (20%), divide the VAT-inclusive price by 1.2. If you are using the reduced rate of VAT in your calculations, you need to divide the VAT-inclusive price by 1.05.

For example, if you have a product with a VAT inclusive price of £25, to calculate the price exclusive of standard-rate VAT, the calculation would go: £25 ÷ 1.2 = £20.83. If it was reduced rate it would be: £25 ÷ 1.05 = £23.81.

When can’t you charge VAT?

There are certain exempt items, also known as ‘out of scope’ items, which you cannot charge VAT on.

If you buy or sell an exempt item, you still need to record the transaction in your general business accounts but it will play no part in your VAT records.

Exempt items include:

  • Burial or cremation of dead people
  • Health services provided by registered health professionals
  • Public postal services provided by the Royal Mail
  • Financial services, such as the transfer of money
  • Insurance services

If your business sells only VAT-exempt goods or services, it can’t be registered for VAT. However, if you start to sell services or goods which are not VAT-exempt you can voluntarily register for VAT if you wish. If the total value of non-exempt goods and services exceeds the VAT threshold (currently set at £85,000) then you must register for VAT.

Some goods are considered to be ‘out of scope’ of VAT (rather than exempt). You can’t charge or reclaim VAT on these goods or services. Examples include statutory fees, goods you sell as part of a hobby, or donations to a charity if you give them without receiving anything in return.

How do you charge VAT to charities?

If your business sells certain goods or services to a registered charity, you can sell them at a zero or reduced rate of VAT. The responsibility is on you to check that the charity is eligible for reduced-VAT rates and to charge the correct rate of VAT.

When it comes to VAT relief, community amateur sports clubs (CASCs) don’t qualify as charities and therefore are not eligible to receive reduced rates of VAT.

Firstly you have to check that the charity is eligible for VAT relief. The charity must provide you with evidence that they are a charity (evidence of their registered-charity status) as well as a written declaration or certificate to prove that they meet the conditions required for VAT relief. Suitable evidence includes their Charity Commission registration number or a letter from HMRC recognising them as a charity if they’re not registered with the Charity Commission for England and Wales (this might be because they are a Scottish or Northern Irish charity).

It is a legal requirement of charities to provide you with an eligibility certificate if you supply certain eligible building or construction services to them at zero VAT. Whilst it isn’t a legal requirement for other reduced or zero rated goods or services, you should still ask to see it so that you can see that the charity is eligible to claim VAT relief. These certificates should include the following information:

  • Address of the building that the construction or building services are taking place.
  • The name and address of the organisation receiving the work, including their VAT registration number and Charity registration if registered for either.
  • Date (or estimated date) of completion of the work.
  • Value (or estimated value) of the work.
  • The name, address and VAT registration.
  • A declaration of the nature of the charitable organisation and their eligibility for VAT relief.
  • A HMRC disclaimer, stating that HMRC can alter the format of the certificate as well as warnings to the issuer and contractor regarding the validity of the certificate.

This written declaration must be a separate document from any order forms or invoices for goods and services. The completed declaration should be kept for 4 years.

What items qualify for a reduced charitable rate of VAT?

If you sell fuel or power under certain circumstances to an eligible charity, you may be able to apply the reduced VAT rate.

You may be able to apply the zero VAT rate if you sell the following goods or services to a charity:

  • Advertising and items for collecting donations
  • Construction services
  • Medicine or medicinal ingredients
  • Drugs and chemicals
  • Aids for disabled people
  • Equipment for making talking books and newspapers for people with hearing impairment
  • Lifeboats and associated equipment including fuel
  • Training resuscitation models

If your business supplies medical or veterinary equipment, there are other instances in which you might be able to provide this equipment at zero-rate, if you sell it to any of the following:

  • NHS Trusts and other particular health bodies
  • Charities which are providing institutional care for chronically disabled or sick people
  • Charities that provide first aid or rescue services to animals or humans
  • Charities which provide transport services for disabled people
  • Research institutions which run on a not-for-profit basis
  • A person who is buying it specifically to donate to one of the above

Eligible items include:

  • Ambulances
  • Rescue equipment
  • Goods used for disabled people
  • Medical, veterinary or scientific equipment.

However, you must make sure that the money being used to buy this equipment has come from charitable or donated sources and this must be explicitly stated on the eligibility declaration.

How do you treat returned goods?

Whether a customer is returning goods to you, or you are returning goods to a supplier, you can settle the balance of payment by issuing a credit or debit note or a replacement invoice. If you exchange the goods for goods of the same value, there is no need for you to issue a new VAT invoice as the VAT amount will be covered by the original VAT invoice.

If you issue a credit or debit note, it must show the same information as the original VAT invoice as well as an explanation as to why this new credit or debit note has been issued and the total amount credited, exclusive of VAT. It must also show the date and number of the original VAT invoice so that your records are all tied up together.

How do you treat free gifts or discounts?

If your business provides discounts or free gifts as an incentive to your customers, you might have to charge VAT on some of these deals.

VAT should be charged as follows:

Offer How you should charge VAT
Discounted goods or services You charge VAT on the discounted price, not the full price
Gifts VAT should be charged in the gift’s full value (there are some exceptions to this which will be detailed later)
Multi-buys VAT should be charged on the combined price if all items are subject to the same VAT rate. If not, VAT should be apportioned as ‘mixed-rate’ goods
Vouchers or money-off coupons You don’t charge VAT if they are given away free at the time of a purchase, otherwise VAT is due on the price you charge for them
‘Face value’ vouchers which can be used for more than one type of good or service No VAT is due if you sell them at or below their monetary value
Redeemed face value vouchers VAT is charged on the full value of the voucher transaction
Redeemed face value vouchers which are sold at a discount VAT is charged on the discounted value of the voucher transaction
BOGOF (buy-one-get-one-free) and other link-save offers VAT is apportioned as mixed-rate goods (unless they are subject to an exception)

As mentioned, there are some exceptions to the above, as follows:

  • There is no VAT due on gifts, if they are given to the same person and their total value in a 12-month period is less than £50
  • VAT is charged on the combined value of link-save (or BOGOF) items if the incentive product has a resale value of less than £1, has a sale value of less than £5, costs you less than 20% of the total of the other items in the offer and isn’t sold at a separate prove from the main product.

There are some free goods and services which you don’t have to pay VAT on.  The following conditions must be met to be outside the scope of VAT:

Supplies Condition to be met so that no VAT is due
Free samples They must be used for marketing purposes only and provided in a quantity which allows your prospective customers sample the product
Free loans of business assets The cost of hiring the asset must be included in something else you sell to the customer
Free gifts The total cost of all gifts given to the same person must not exceed £50 in a 12 month period
Free services Yu mustn’t receive any payment or goods or services in return (for example, you can’t use a system of bartering)

How do you treat services provided to EU businesses?

As things currently stand, if you supply services to a business in the EU, you don’t need to charge VAT because the customer is responsible for paying any VAT in their own country.

However, there are different rules for some services such as:

  • Transport hire
  • Property or land services, such as valuation services or repair services
  • Catering services, including restaurants
  • Broker or agent services (or other services where you act as an intermediary)
  • Digital services
  • Event services
  • Services you do to other people’s goods, such as cleaning or making alterations.

If your business is involved in the supply of any of the above services to businesses in the EU, you will need expert advice to ensure that you are treating your VAT correctly.

How can DSR Tax Claims Ltd help?

We know that setting up a new business can be pretty complex – there’s so much to think about and that’s before you start thinking about sorting out your VAT. Our friendly team of tax specialists at DSR Tax Claims Ltd are on hand to help make life easier for you. We’re the experts at identifying your maximum allowable expenses so call us on 0330 122 9972 – we’re the tax experts you can trust.