Value added tax

BLP.16 - Value Added Tax (VAT)

VAT is governed by the Value Added Tax Act 1994 (VATA 1994) and administered by HMRC. It is collected through the supply chain; a consumer normally bears the final cost.

The core mechanism

• Output tax is VAT charged on the business's supplies.
• Input tax is VAT on its business purchases, subject to the statutory rules; not every VAT charge is deductible.
• Net VAT payable is output tax less deductible input tax. A repayment can arise where deductible input tax exceeds output tax, subject to the return and claim conditions (ss.24-26).
• Apply the rate to the VAT-exclusive price. At 20%, VAT included in a gross price is one-sixth of that price, not 20% of it (s.19(2)).

Five elements of a charge to VAT

There must be: (1) a supply of goods or services; (2) made in the UK; (3) that is a taxable supply; (4) by a taxable person; (5) in the course or furtherance of business (s.4(1)). A taxable supply is a supply other than an exempt supply (s.4(2)).

Rates and categories

• Standard rate: 20%, the default for most supplies.
• Reduced rate: 5%, for qualifying supplies in Sch.7A, including domestic fuel/power for qualifying use (s.29A).
• Zero-rated: 0%, for qualifying supplies in Sch.8, such as most food, books and children's clothing. These remain taxable supplies, despite no output tax being charged (s.30); attributable input tax is recoverable subject to the normal conditions and restrictions.
• Exempt supplies under Sch.9 include specified insurance, finance, land/property, education, health and welfare supplies. Check the particular exemption and its conditions, not just the supplier's industry. Input tax attributable to exempt supplies is generally irrecoverable, subject to the exceptions below.
• Private schools: since 1 January 2025, education and vocational training supplied by a private school, and closely related board and lodging, fall outside the exemptions under Sch.9 Part 3. The education item excludes teaching English as a foreign language, nursery-class education and higher-education courses; their own exemption conditions still matter. Do not treat all education as exempt, or all private-school provision as standard-rated (FA 2025 ss.47-49).

Registration

• Historic test for a UK-established person: at the end of any month, taxable supplies in the preceding 12 months exceed £90,000 (Sch.1 para.1(1)(a)). The person does not become liable under this test if HMRC is satisfied that taxable supplies in the following year will not exceed £88,000 (para.1(3)). A small excess alone is not an exception.
• Future test: at any time there are reasonable grounds to believe taxable supplies in the next 30 days alone will exceed £90,000 (para.1(1)(b)). Do not confuse this with expected turnover over a year. The historic-test £88,000 exception does not disapply this separate test.
• Historic-test dates: notify HMRC within 30 days of the end of the relevant month. Registration takes effect from the end of the following month, or an earlier agreed date (Sch.1 para.5). For a March threshold crossing, the ordinary dates are notification by 30 April and registration from 1 May.
• Taxable turnover includes standard-rated, reduced-rated and zero-rated supplies; exempt supplies do not count. Special statutory exclusions and registration routes can matter, including capital-asset disposals and persons not established in the UK. The £90,000 test above is not a universal threshold for every supplier.
• Voluntary registration can be available below the threshold for a person making, or intending to make, taxable supplies. It does not make exempt supplies taxable or make all purchase VAT deductible.

Input tax recovery

• Under s.26(2), creditable input tax is attributable to taxable supplies, supplies outside the UK that would be taxable if made in the UK, or specified supplies under Treasury orders. Certain financial and insurance services to customers belonging outside the UK can be specified supplies (Specified Supplies Order 1999 art.3). Do not infer irrecoverability merely from the word "exempt".
• Business/non-business use: apportion VAT on purchases used partly for business and partly for other purposes (s.24(5)). Then apply the recovery and blocking rules.
• Blocked entertainment: VAT on business entertainment is generally excluded from credit. Reasonable entertainment of qualifying overseas customers is an exception. Entertainment provided only for employees or, where the taxable person is a company, its directors or others engaged in its management is outside this definition unless it is incidental to entertainment provided for others (VAT (Input Tax) Order 1992 art.5(3)); its VAT is still recoverable only if the normal business-purpose and attribution rules are met.
• Partial exemption: distinguish input tax directly attributable to taxable supplies, input tax directly attributable to exempt supplies, and residual input tax used for both; apportion residual input tax under the applicable method (VAT Regulations 1995 reg.101). Under the standard de minimis test, input tax attributed to exempt supplies is treated as attributable to taxable supplies, and so recoverable, where it is no more than £625 per month on average AND no more than half of all input tax for the period (reg.106(1)); the test applies where reg.105A does not and is subject to regs.106A and 106ZA. Longer-period adjustments and the applicable statutory conditions must also be checked (regs.106-106A).
• Evidence: a domestic purchase claim normally requires the appropriate VAT invoice. HMRC may direct other evidence of the charge; imports and other categories have their own document requirements (reg.29(2)). An invoice alone does not override a blocked-cost or exempt-use restriction.

Accounting and common traps

• Registered businesses normally submit quarterly VAT returns and comply with the applicable Making Tax Digital requirements, accounting for output tax less deductible input tax.
• Zero-rated is not exempt: zero-rated turnover counts towards registration and can support input-tax recovery. Exempt turnover does not count, and its attributable input tax is generally a cost unless an applicable recovery exception applies.
• VAT is a transaction tax, not a tax on profit. Do not substitute income-tax or corporation-tax thresholds.
• A taxable person may be an individual, partnership or company. Registration attaches to the person/entity, not each separate business activity.

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