Are you a new entrepreneur and wondering how does VAT work in the UK? If you said “yes” to that question, you’ve found the right place to get your answer today!

Financial jargon can be daunting for many, especially new business owners. From dividends to Corporation tax, there are many different terms you’ll need to learn when you first register a company and set up your business.

But Value Added Tax (VAT) is definitely a term you should master. In fact, knowing how VAT works is essential for entrepreneurs, traders and individuals to follow tax laws and make smart financial decisions.

VAT is not a financial term only for business owners. You’ll always encounter VAT when buying goods and services as a private person or a business. But what is it, and how does UK VAT work in the UK when you’re the one applying it to your goods and services? Navigating through UK VAT formalities shouldn’t be so hard if you can hire expert professionals who can take care of UK vat registration for you.

Today, let’s learn everything we need to know about VAT registration in the UK and VAT return UK.

Let’s Start With Definition of UK VAT

VAT is a consumption tax charged on the value added at each step of production or distribution of goods and services. It is an indirect tax paid by businesses for the government and transferred to the final consumer.

In simple terms, consumers have to pay a tax on the goods and services they purchase based on the value of the transaction. VAT rates are percentage-based, which means the higher the price, the more the consumer has to pay.

Therefore, VAT is a major income source for the government and is widely used in over 250 countries around the world. So, it is no different in the United Kingdom as well.

How Does UK VAT Work for Businesses?

VAT covers almost all goods and services. VAT-registered businesses act as unpaid tax agents, applying UK VAT to what they sell to the consumer and passing it on to HMRC.

To simplify this for companies, they have to submit a VAT return UK showing the total they’ve received and the total they’ve spent within the tax quarter or year.

The difference between VAT paid and VAT collected is based on input tax and output tax. Input tax means the VAT paid by you to suppliers for equipment, materials and costs. This also includes professional services like consultancy fees or accountancy services.

On the other hand, output tax means the VAT applied to customers on the goods or services sold. By recording input and output tax, businesses can precisely calculate their net VAT obligation during the VAT return UK process.

What is a VAT Threshold?

VAT is mandatory after your business hits a certain tax limit. As of 2020, this VAT limit is £85,000. Any income on goods and services after gross income goes over £85,000 must have VAT. Earnings before the cap do not need to have VAT.

For instance, if your business makes £90,000 in a year, when you first sign up for VAT, only £5000 is taxable income for VAT. The rest is free from VAT. If you make £84,999 or less, you do not need to pay VAT.

Small businesses do not have to charge customers VAT right away because it always makes your prices go up, or your income go down, depending on how you choose to handle VAT charges to customers.

To keep up with the competition, some businesses may have to cut costs so they do not scare away customers. Therefore, a limit helps low-income small businesses to balance their finances and stay in the market by charging customers lower prices.

Once you are VAT signed up, you must stay VAT signed up until you start making less than £85,000 a year. This means that, unlike tax allowances, the £85,000 allowance does not start over at the start of the next tax year.

Which Products and Services Qualify for VAT Exemption?

VAT is not charged on all goods or services. If some goods are exempt from VAT, this means that the government does not want to tax certain basic social needs of humans. These products and services are basically the ones that are considered as equal human rights.

Some examples of VAT-exempt things are listed below:

Education and training
Financial services like insurance and banking
healthcare and medical services
Fundraising events by charities
Certain types of cultural and sporting events
Necessities like certain food items, water, domestic gas and electricity

Businesses that solely offer VAT-exempt goods or services are not eligible to register for VAT or claim input tax on purchases.

How to do VAT Registration in the UK?

Here’s a step-by-step way to easily complete your VAT registration UK below.

Step 1: Sign up for VAT with HMRC. This lets you send a VAT return, like a self-assessment tax return. If you are a sole trader, you can sign up yourself for VAT. If you have a limited company, the small business needs to be VAT signed up.

Step 2: Avoid investigations and penalties by registering for and paying value-added tax. VAT is mandatory. You will get in trouble if you send a tax return for your business over the £85,000 limit but don’t register for or pay any value-added tax.

Step 3: Charge VAT to customers on goods and services after you are registered for VAT and are making above the limit.

How to Charge UK VAT to Customers?

As a UK business, you add VAT to the selling prices of taxable goods and services based on the relevant VAT rate.

When you send an invoice to your customers, it should show the VAT amount charged separately. For instance, if the VAT rate is 20%, and your product costs £100, you would add £20 as VAT, making the total invoice amount £120.

It’s vital to make sure that your VAT charges are correct, and you must keep proper records of all transactions for VAT compliance and file VAT returns to HMRC at the needed intervals.

How to Submit VAT Return UK?

In the UK, one “accounting period” is completed every three months. This is the gap after which every business needs to submit a VAT return UK to HMRC. Even if you have no VAT to pay or claim, you still need to file a return at the end of every accounting period, since your business is registered for VAT.

Here’s how you can do this:

Log in to create your UK Government Gateway account on the HMRC website
Then, scroll to the “VAT” section and select “Submit a Return” option
Enter all the required information for the VAT period
Verify and send HMRC the VAT return UK online
Depending on the outcome of the return, pay any applicable VAT liability or request any applicable VAT refund
For compliance purposes, keep copies of the VAT return that you submit and any relevant documentation for atleast six years

FAQs

What are the benefits of being a VAT-registered business?

You can get back VAT on goods and services bought for your business
You can sign up for the Flat Rate Scheme, which can make your VAT returns easier and cheaper
You will have a more trustworthy image for customers and suppliers, thus boosting sales and brand awareness
You will have a clearer idea of your costs, as you will have to monitor all VAT payments and receipts and handle finances better

How much VAT should you charge?

In the UK, legally you can charge upto 20% of the selling price as VAT on your products and services.

When should your business start charging VAT?

In the UK, your business has to charge VAT when its taxable turnover goes over the VAT registration UK limit of £85,000. When your business goes beyond this limit in any 12-month period in a row, you have to register for VAT with HMRC and start applying VAT on your taxable sales of goods and services.

Key Takeaways on How Does UK VAT Work

To sum up, here’s everything we learned today. Your business qualifies for VAT registration when taxable turnover goes over £85,000. Signing up for VAT can be a difficult and lengthy process for new business owners.

Remember that once you sign up for VAT, you have to add VAT to all eligible goods and services you offer. You can then get back the VAT you’ve spent on expenses for your business. VAT-registered businesses in the UK have to send VAT invoices to HMRC every 3 months. This is true even if you didn’t offer VAT-applicable products or services in the relevant financial period.