Recap: How VAT works

There is a shortcut. Out of every £120 of a gross price at 20%, £20 is VAT. 20 out of 120 is one sixth.

VAT fraction

the share of a gross price that is VAT. At 20% it is 1/6.

So at 20%, the VAT is the gross divided by 6. At the reduced rate of 5%, £5 out of every £105 is VAT, so the VAT fraction is 5/105.

A business under the threshold may still choose to register. This is called voluntary registration.

• A registered business must charge VAT on its taxable sales
• It must give VAT invoices that show its VAT registration number
• It must keep VAT records and send VAT returns to HMRC
• In return, it can claim back the input tax on its purchases

A business that is not registered must not charge VAT. It cannot claim any back either, so the VAT it pays is part of its costs.

A sale that VAT applies to is called a taxable supply. Every taxable supply carries one of three rates.

Standard rate, 20%

most goods and services

Reduced rate, 5%

a short list, such as children's car seats, and gas and electricity for a home

Zero rate, 0%

a longer list, such as most food, books, and children's clothes and shoes

The rate depends on what is sold, not on who sells it. The lists are set by law and are published on GOV.UK.

Some sales are exempt. The law says no VAT is charged on them at all.

• Insurance
• Postage stamps
• Bank charges and interest on a loan
• Most health care and education
• Rent on a home

The seller of an exempt supply charges no VAT. It also cannot claim back the input tax on the costs of making that sale.

At the end of each VAT period, usually three months, the business sets its input tax against its output tax.

• Output tax is more than input tax: the business pays the difference to HMRC
• Input tax is more than output tax: HMRC pays the difference to the business

So HMRC only ever receives, or pays, the difference between the two.

A VAT inclusive price is the gross price: net plus VAT. At 20%, the gross is 120% of the net.

• Net is the gross divided by 1.2
• VAT is the gross less the net

Taking 20% off the gross gives the wrong answer. The VAT was 20% of the net, and the net is the smaller figure.