Skip to Content

Back to Tax Basics: How does VAT work?

Back to Tax Basics: How does VAT work?

Value-added tax (VAT)  is a consumption tax that’s levied on goods that have had value added at each stage of the supply chain.

Most businesses with annual sales of £85,000 or more have to register for VAT. And even if your sales are below that level, you can register on a voluntary basis. VAT can be confusing, though, with different rates, options and, in some cases, quite complex rules to consider.

So, is your business likely to be required to pay and collect VAT? And why do we have VAT in the first place?

1. The key requirements for a VAT-registered business 

In essence, VAT should be a simple form of taxation. As a VAT-registered business, you must:

  1. Charge VAT to your customers 
  2. Deduct VAT you have been charged by your suppliers
  3. Pay the difference over to HMRC (or claim it back if there’s a refund). 

In basic terms, your business is acting as an unpaid tax-collector, and the actual burden of the tax is on unregistered businesses and individuals who are charged VAT but can’t claim it back.

2. A short history of VAT

When VAT was first introduced in 1973 there was a single rate of 10% which applied to most goods and services. This kept things simple and straightforward across the board.

The first indication that the basic simplicity wouldn’t last came in July the following year, when a rate of 12.5% was introduced on petrol and luxury goods, and that ‘luxury’ rate was then doubled to 25% four months later. The luxury rate was abolished in 1979.

A reduced rate of 8% was introduced in April 1994 and applied to domestic fuel and power, which was previously 0%. The reduced rate now stands at 5%.

Without covering all aspects of the tax, here are some common queries.

3. When do I have to register?

As we’ve mentioned, it’s not mandatory to register for VAT until you reach the current VAT threshold of £85,000. But what should you do when this looks imminent?

If you believe your VAT taxable turnover will exceed £85,000 during the next 30 days, you need to register by the end of that month and start charging VAT from the 1st of the next month. 

Where you have a VAT taxable turnover of over £85,000 in the immediately preceding 12 months, you have to register by the end of the next month – and start charging by the 1st day of the second month after you went over the limit. This is a rolling 12-month period, not a calendar, tax or business year, so if you think you may be close to that point you should check each month.

4. When should I consider registering on a voluntary basis?

Even if you’re below the threshold for compulsory registration, you may want to register on a voluntary basis. There are two main reasons that businesses do this:

  1. Sometimes people believe that, cosmetically speaking, they appear bigger or more successful if they’re VAT registered, and that alone is enough to persuade some people.
  2. Secondly, if most of your customers are themselves VAT-registered, then the VAT you charge isn’t a real cost to them, and you can benefit from reclaiming VAT incurred on your own purchases. Because of this, you can make more profit as a VAT-registered business that otherwise would be lost to tax.

5. What’s the difference between the invoice basis and the cash basis?

VAT is accounted for on either a quarterly or (less common) monthly basis. There are two different ways that you can account for the VAT:

  • On an invoice basis, you include VAT on sales based on your invoice dates, and deduct VAT charged by your suppliers based on their invoice dates.
  • On the cash basis, the relevant dates are when your customer pays you, and when you pay your supplier.

If your customers pay immediately, but you purchase on credit, then the cash basis would suit you well. From a timing viewpoint, you would be reclaiming VAT on your purchases earlier. If, on the other hand, your customers typically take a while to pay, while you settle your supplier invoices quickly, then the invoice basis may be better.

6. What rates should I charge?

There are currently 3 VAT rates to choose from:

  • The standard rate of 20% applies to most goods and services.
  • The reduced rate of 5% applies to domestic gas and electricity, and to supplies in the construction industry, such as certain building renovations and alterations. It also applies to some energy-saving materials installed in residential properties, to child car seats and some mobility aids. The reduced rate has been temporarily extended to some aspects of the hospitality industry over the course of the pandemic.
  • Zero-rate (0%) applies mainly to everyday items, like basic foods, children’s clothing, books and newspapers etc.
  • There is another category, which is called ‘exempt’. This is where no VAT is charged, but the business supplying it cannot reclaim any VAT they incur in respect of such supplies. This includes items such as postal services and health services.

7. What VAT can I reclaim?

Presuming that you don’t make exempt supplies, then you can reclaim all VAT you incur in respect of your purchases. 

This includes:

  • Goods, services and materials to be incorporated into things you sell 
  • Expenses such as stationery and telephone charges
  • Most capital purchases, such as computer equipment and commercial vehicles. 

The main exception is if you buy company cars, where the VAT is not reclaimable, or items with mixed business and personal use where part or all of the VAT may be blocked.

8. What are these VAT schemes I’ve read about?

There are a number of VAT schemes which are available to businesses. 

Some, such as the second-hand margin schemes, apply to specific industries such as used motor vehicles, art and antiques. Others, such as the flat-rate scheme and the annual accounting scheme, aim to simplify the workings of the VAT system.

9. What impact will VAT have on your business?

Where you register for VAT, apart from handling the administration, there is no net VAT ‘cost’. 

When paying the quarterly VAT bill, it’s simply tax you’ve added on to your charges to your customers, less any additional amounts you’ve paid to your suppliers.

Where VAT can have a significant financial cost, though, is where you don’t follow what are increasingly complicated rules. So, for example, being prevented from claiming back costs on your purchases because you didn’t check that your suppliers’ invoices are valid, or charging the wrong rate – or not charging at all – to your customers.

Talk to us about giving your VAT the once-over

This overview is a basic primer to VAT but there are lots of detailed industry-specific rules that apply in various circumstances. So getting professional advice is always a good idea.

As tax specialists, we can help you:

  • Decide whether or not you should register voluntarily
  • Run a ‘health-check’ of your systems if you’re already VAT-registered
  • Make sure you’ve considered any of the applicable special VAT schemes.

Get in touch to talk about your VAT needs.

What our clients say

For us, there is nothing better than a happy customer. Here are just a few that let us know how much we mean to them.

Pete Dungey

Simple, efficient and most importantly, hassle-free.

We found Panthera via our search for a Xero expert. We knew the software we wanted to use, and needed a forward-thinking accountancy partner who could get us up and running, and teach us the ropes moving forward. Tory and her team have always been on hand to answer our questions, and help us to grow as a business, particularly during periods of big change, such as becoming VAT registered. They are always on hand to alleviate any concerns and help to keep our records in order, which makes our year-end accounts an absolute breeze! Being based in Bristol, our relationship is entirely email based, alongside one consolidation meeting at year end - this keeps things simple, efficient and most importantly, hassle-free.

Pete Dungey Kaleido Grafik Limited
Anita van Eijndhoven

Talk Our Language

The support and service we receive from Panthera Accounting is very good. Everything from regular meetings, a prompt e mail response and the transition of our Xero software (which we find very pro active indeed) has and is all remarkably efficient. We find Panthera talk our language and make any process as painless and easy as possible.

Anita van Eijndhoven Quidne-IT
Ash & Tim Lane

Panthera brush aside the stereotype of the typical accountant

We got in touch with Panthera Accounting by way of a recommendation; we haven't looked anywhere else since. They are an extremely professional yet relaxed group of people. We were slightly daunted by the idea of accountants but Panthera brushed aside y the stereotypes. They are very understanding when answering any questions we may have. They are completely efficient, offer sound business advice, and are fantastically priced. We will continue to recommend them.

Ash & Tim Lane Starveacre Fencing
Jayne Johnson

An Asset to my Business!

The whole team at Panthera are great! Working with them has been a huge support to my growing business. They help me to understand the numbers I need to know. They give me technology solutions like Xero so that I can process things quickly and have access to my own figures. They are quick to reply, highly knowledgeable, nothing is too much trouble and as well as making sure that everything is compliant and on time, they are enthusiastic, professional and fun to work with.

Jayne Johnson Better People
John Baker

Absolute joy - they provide a first class service on every level

Working with Tory and the team at Panthera is an absolute joy - they provide a first class service on every level; from simple Xero issues through to more complicated tax enquiries, they’re always on-hand to help me get it right. I’m certainly not their biggest customer, but I’m always made to feel like their most important one.

John Baker BKR Solutions
John Castle

Professional and Friendly

I would like to say that Panthera Accounting have helped me with my business accounts for more than 4 years now. They have consistently offered an excellent competitively priced service that works both professionally and in such a friendly way that I would highly recommend them to everyone considering using their services.

John Castle Ilexanna Limited & Birch Castle Homes Limited
Jonathan Morrison

They are always there to answer queries and sort out issues

I had been with Mr Dunn for 20 years when upon his death Panthera took over the business. They now play a bigger part in the running of my business, they do all the stuff that has to be done but I don't like doing ie book keeping, VAT, wages, and returns. They are always there to answer queries and sort out issues and make sure all Tax deadlines are met. Their costs are fair, service is great and I have and would highly recommend them.

Jonathan Morrison Wallingford Builders
Pippa Scott

Professional, friendly and personal service.

Panthera Accounting have gone above and beyond the call of duty to guide and support our Company. They offer a professional, friendly and personal service that can take the stressful and sometimes frightening feelings out of running a business. They have guided us through the working of Xero and have offered “teaching sessions” on the day to day running of the accountancy package. Our only regret is that we didn’t join their team earlier.

Pippa Scott Scott's Commercial Services Limited
Sara Southey

Panthera puts the personal back in to accountancy!

Tory and her team have provided a friendly, approachable and helpful service from the start. They have delivered a quality service, above and beyond anything I could have expected. Panthera, with the help of the Xero package, have taken the stress, strain and confusion out of managing my company and personal accounts. I look forward to working with them for many years to come.

Sara Southey Bluestones Garden Design
Tracey Miller

Panthera are fantastic.

Panthera are fantastic. Always professional, going the extra mile for their clients and delivering superb service. I recommend them all the time to my clients.

Tracey Miller Bigger, Brighter, Bolder BBB

Contact Us

Panthera will use the details that you have entered into this form to communicate with you on the subject of your message, and for no other purpose.
Please see our privacy policy for more details on how we manage your data.

Lets Get Started

Move to Panthera

Moving to Panthera is as easy as 1,2,3...

  1. We jump on a quick call to create the perfect service package for your business
  2. You e-sign your terms of engagement
  3. We get your authority to talk to HMRC on your behalf

And that’s it! From contacting your previous accountant, to updating Companies House with your new registered office address, let us handle all of the admin so that you can get on with running your business, safe in the knowledge that everything is going smoothly in the background.

Talk to Us