Understanding VAT supplies and registration
To determine whether a transaction is subject to VAT, or counts towards your VAT registration threshold, it must meet all of the following criteria:
1. It must be a supply of goods or services
This excludes:
- Income that is exempt from VAT (e.g. certain rents, financial services).
- Income outside the scope of VAT (e.g. grants, interest income). See VAT and grants.
2. It must be made in the UK
For most UK-based businesses serving UK customers, this is straightforward.
However, if you have international clients or suppliers, the rules can be complex. See VAT on international transactions.
Please note: Supplies made outside the UK are not subject to UK VAT, but may trigger mandatory VAT registration in other countries, even for small amounts.
VAT basics
When you make a VATable supply, you must add VAT to your sales price. This is your output tax.
If you sell to consumers, your prices are assumed to be VAT-inclusive.
For example, if you charge £12 for a standard-rated item:
Net income: £10
VAT (output tax): £2
This VAT is reported and paid to HMRC.
When you purchase goods or services for your business and are charged VAT, this is your input tax.
You can usually reclaim this, provided:
- The purchase is used for VATable business activities
- You have a valid VAT invoice
Note: Some VAT (e.g. on cars or entertainment) is not reclaimable.
VAT rates
- Standard rate (20%) – Default rate for most goods and services
- Reduced rate (5%) – Applies to specific items (e.g. home energy)
- Zero rate (0%) – Applies to certain goods (e.g. most food, books)
VAT-Exempt supplies
Some supplies are exempt from VAT, meaning:
- You do not charge VAT on sales.
- You cannot reclaim VAT on related purchases.
Common examples:
- Rental income (if it’s purely for space, not bundled with services like reception or membership)
- Financial services, such as pension management
If you have exempt income, you may need to apportion input VAT on shared costs (e.g. phone bills, accountancy fees) and not reclaim this. We can help you apply the correct rules.
Outside the scope of VAT
Some income is entirely outside the VAT system and:
- Does not count towards your VAT registration threshold
- Is not subject to VAT, even if you are registered
Examples include:
- Grants (if they are genuine and not in exchange for services)
- Interest received (e.g. on loans to directors)
- Loan repayments
- Insurance payouts
- Payroll income (for sole traders)
- Income from overseas supplies (see VAT on international transactions).
Special schemes and considerations
- Flat Rate Scheme (FRS): You still charge VAT as normal, but your VAT return is calculated using a flat rate percentage of your gross turnover. Only beneficial for companies that are not defined as limited cost businesses
- Option to Tax (for landlords): A landlord can elect to charge VAT on rental income to reclaim VAT on property-related costs. This election is binding for 20 years. Always seek advice before opting
If you’d like to explore how these rules apply to your business, we’d be happy to help. Book a free online meeting and let’s talk it through.