What is VAT (Value Added Tax)? A Complete Guide

Do you know how our everyday purchases help governments fund the public services that are so integral to our daily lives? This is all because of the Value Added Tax (VAT), a tax pouring its financial magic at every stage of the supply chain, from production to the checkout counter. But What is VAT, and how does it work? This blog offers a detailed answer, delving into everything from its current rate in the UK and the thresholds to how to calculate VAT and get a refund. So read on and understand how VAT shapes economies! 

Table of Content 

1. What is VAT? 

2. Current VAT Rate in the UK 

3. Purpose of VAT 

4. How VAT Works? 

5. How Much Money Does VAT Raise? 

6. Who is Responsible for Collecting VAT? 

7. VAT Threshold 

8. How to Calculate VAT? 

9. Items Subject to VAT and Exempt from VAT 

10. VAT on Imports 

11. VAT on Exports 

12. How to get a VAT Refund?  

13. How do you File and Pay VAT? 

14. Conclusion 

What is VAT? 

VAT is a consumption tax, that's applied to the majority of goods and services across the United Kingdom (UK). It's levied at each supply chain stage, from production to the final consumer. Here are some important aspects of VAT: 

1. Registered businesses must charge VAT on their supplies 

2. They must pay it to His Majesty’s Revenue & Customs (HMRC) 

3. They can reclaim VAT on business expenses 

As an indirect tax, VAT is paid by consumers in the product price, collected by businesses, and reported to HMRC. This ensures compliance with government regulations. 

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<H2> Current VAT Rate in the UK 

The following table summarises the VAT rates and applications in the UK: 

UK’s Current VAT Rates 

Purpose of VAT 

The purpose of Value-Added Tax (VAT) includes the following: 

1. Ensuring consistent revenue generation 

2. Generating tax revenues for governments 

3. Promoting economic choices without distortion 

4. Finance public expenditure, including education, infrastructure development, healthcare, and other essential services. 

5. Providing incentives for businesses to keep invoices 

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How VAT Works? 

VAT is collected at every stage of a product's journey—each time value is added and a sale occurs. This process defines VAT as a value-added tax, ultimately paid by the consumer. Here’s how it works: 

1. A supplier sells a cricket bat to a retailer for £150, including £25 VAT owed to HMRC 

2. The retailer reclaims the £25 VAT, meaning they effectively don’t pay VAT 

3. The retailer sells the bat to a customer for £300, charging £50 VAT, which the customer pays in full. 

4. The retailer, after reclaiming the £25 VAT, pays £25 to HMRC 

How Much Money Does VAT Raise? 

Taxes on consumer spending are the government’s second-largest revenue source, with VAT contributing the most. In 2024-25, VAT is projected to generate £175.6 Billion (excluding refunds to certain public sector organisations). This accounts for 15.4% of total revenue, equivalent to £6,100 per household and 6.3% of the national income. 

Who is Responsible for Collecting VAT? 

Businesses play a crucial role in the VAT system, as they are responsible for collecting and remitting the tax to relevant tax authorities. As an indirect tax, VAT is added to the prices of goods and services being sold to customers, who ultimately bear the cost, while businesses facilitate its payment. 

2023/2024 Statistics for VAT 

VAT Threshold 

As announced at Spring Budget 2024, here are the key details about the VAT thresholds: 

1. The 12-month taxable turnover threshold determining whether a person must be registered for VAT has increased from £85,000 to £90,000.  

2. The 12-month taxable turnover threshold, which determines whether a person may apply for deregistration, has increased from £83,000 to £88,000.  

3. For Northern Ireland, the registration and deregistration thresholds for acquisitions have increased from £85,000 to £90,000. 

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How to Calculate VAT? 

Here are the ways to calculate VAT: 

1. Total price including VAT - Standard Rate 

   As mentioned above, the standard rate applies to most goods and services. 

   a) To calculate the total price at the standard VAT rate (20%), multiply the original price by 1.2.   

   b) To determine the reduced VAT rate (5%), multiply the original price by 1.05 

2. Total price excluding VAT - Reduced Rate 

   a) You can determine the total price, excluding the standard VAT rate (20%), by dividing the original price by 1.2.   

   b)To calculate the reduced VAT rate (5%), divide the original price by 1.05 

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Items Subject to VAT and Exempt from VAT 

VAT is charged on the following taxable supplies: 

1. Hiring or loaning goods to someone 

2. Goods and services (service refers to anything other than supplying goods) 

3. Commission 

4. Selling business assets 

5. Items sold to staff (for instance, canteen meals) 

6. Business goods that are used for personal reasons 

7. ‘Non-sales’ like part-exchange, bartering and gifts 

Tax Collector Average Annual salary 

Some big examples of VAT-exempt goods and services are: 

1. Investments, financial services and insurance 

2. Parking spaces, garages and houseboat moorings 

3. Education and training (excluding private schools) 

4. Healthcare and medical treatment 

5. Buildings, property and land 

6. Burial or cremation services and funeral plans 

7. Antiques and charity events 

8. Gambling or lottery tickets 

9. Sports activities 

VAT on Imports 

You must generally pay VAT on goods you import into the UK. The VAT may be added to the price when you pay customs. You can usually claim it back when submitting your VAT return. Here are some important points regarding import VAT: 

1. VAT-registered businesses can use postponed VAT accounting to declare and reclaim import VAT on the same VAT Return. 

2. Postponed VAT accounting allows businesses to reclaim import VAT as input tax, following normal rules. 

3. Businesses can also opt to pay import VAT at the time of importation and reclaim it as input tax, subject to the same rules. 

4. To claim input tax, the import VAT statement is required as evidence 

5. Shipping or forwarding agents typically cannot reclaim input tax since the goods are not part of their business use. 

When was VAT Introduced in the UK? 

VAT on Exports 

VAT is not charged if goods are exported from: 

1. Northern Ireland to a place outside the UK and EU 

2. Great Britain to a destination outside the UK 

 Here are some key points to remember: 

1. The sale can be zero-rated if you obtain and retain evidence of the export and meet all conditions. 

2. You must ensure the goods are exported within the required timeframe 

3. You should obtain evidence of export within three months from the time of sale 

4. The timeframe can be extended for goods requiring processing before export (or for thoroughbred racehorses). 

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How to get a VAT Refund? 

You can get a VAT refund by following these steps: 

1. Complete the Application Form: First, you must get a Tax Refund Application Form (called VAT 407) from the retailer. Additionally, you might be asked to show your passport for the purpose of checking your eligibility.  

2. Customs Check: At customs, you must present the following: 

   a)VAT form(s) 

   b) Your passport 

   c) VAT invoice(s) 

   d) Tax-free goods   

3. Approval and Refund: Once all the criteria are fulfilled, customs will approve your form and issue a signed document allowing you to receive the refund. 

How do you File and Pay VAT? 

Filing and paying VAT involves several steps, which can vary depending on the country. Here’s a general overview: 

1. Register for VAT: First, ensure your business is registered for VAT. This typically involves providing information about your business, such as its name, location, and annual sales.  

2. Maintain Accurate Records: Maintain detailed records of every sale and purchase, including the VAT charged and paid. This is crucial for accurate filing.  

3. Calculate VAT: Determine the amount of VAT you owe by subtracting the VAT you paid on business-related purchases (input VAT) from the VAT you collected on sales (output VAT).  

4. File VAT Returns: Submit your VAT return to the tax authorities, usually quarterly or monthly. This can often be done online through the tax authority’s website.  

5. Pay VAT: Pay the amount due to the tax authorities by the deadline. This can typically be done via direct debit, bank transfer, or other electronic payment methods. 

Conclusion 

In conclusion, VAT is a crucial element of global economies that ensures governments can fund essential services. From production to purchase, it impacts businesses and consumers alike. Understanding What is VAT keeps businesses on their toes, encourages them to stay compliant, and helps consumers appreciate its role in shaping the world of commerce. 

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