When recording your transactions within your bookkeeping system it is important to make the distinction between zero rated items and exempt items for VAT purposes. Although neither will have VAT charged on them they are treated very differently for the purpose of the VAT calculation. Not using the correct rate will mean that the figure declared for the value of the purchases (box 7) for the period will not be accurate.
Exempt items
Such items should not be included on the VAT return.
Common exempt items are insurance, Royal Mail postage services, rent (assuming no option to tax), education and vocational training supplied by recognised bodies, bank charges and interest, membership subscriptions to professional bodies, donations, salary payments, payments to HMRC, dividends and payments of loans. This is not intended to be the complete list and further details can be found VATA 1994, Schedule 9.
When recording such items in Xero you should use the rate “No VAT”, other bookkeeping systems may use the rate “n/a”.
Zero rated items
If your receipt/ invoice does not show VAT, and it is not an item covered in the exempt section above, then you should record this in Xero using the rate “Zero Rated Purchases”, other bookkeeping systems may simply use the rate “0%”. Any items recorded in this way will then be included within the total purchases (box 7) figure for the period.
Common items that are always zero rated are food (with some exceptions), books, public transport (not taxis) and clothing (children and protective clothing).
Remember you must have a VAT invoice to support any input tax (VAT on purchases) claim. If you do not have this you should not be reclaiming the VAT.
Blocked input tax
There are some cases that even when input tax (VAT on purchases) has be charged it is not recoverable. Common examples of these are business entertainment, cars that are available for private use and lease cars available for private use (50%).
You should record these items without VAT in the same way as the zero rated items.