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Value Added Tax

Find out what you need to know about forming a UK company

A Guide to Value Added Tax

Most of you must have heard about VAT, whether you like it or not. But what most are ignorant about, is what makes VAT necessary, or how it works. It is important to know everything about VAT if you are a business looking to levy VAT upon its products, because VAT, just like any other tax, can easily land you in trouble. VAT, or Value Added Tax, is the charge that is placed on products/services by the manufacturer itself and paid to HMRC.

Any goods or services fall under the following two categories:

  • VAT-rate or
  • Vat-exempt

VAT-exempt could be achieved by the size of annual revenues or the nature of goods and services. For example, gambling money, rent payments, health services and financial services are all exempted from VAT. If the annual sales of a company are less than 67000 pounds, then also it is exempted from VAT. In the latter case, however, the company can volunteer to register for VAT early, to save from any legal troubles once it exceeds the threshold limit.

There is no standard rate of VAT. While the average is 20%, the rate differs depending upon the type of goods. For instance, goods like children's car seats and mobility aids need to pay 5% reduced rate of VAT. Some products, due to their sheer necessity, are zero-rated. Safety equipment’s like cycle helmets and hard hats fall under this category, such as children’s attire and footwear.

Working of VAT

In order to be able to levy VAT, you need to first register for it. The registration could be done voluntarily or when you or your products become eligible to pay VAT.  Once that is done, you can levy VAT on any of the 'taxable supplies'.

These include:

  • Products sold to the employees/staff
  • Commission
  • Direct business sales (most common)
  • Sale of business assets
  • Business products used for private reasons
  • Exchange of goods for semi-business purposes

You are free to charge VAT on any products or services supplied, but there are certain laws to be followed. The amount of VAT charged and VAT paid must be reported to the HMRC. The VAT Return, filed every quarter, must contain these details, including the complete value of what you got in return of the goods and services sold (even if what you got in return was non-monetary). This is to combat any possible tax evasion that usually includes bartering non-monetary items in exchange of goods.

In case extra VAT is not levied upon your products, HMRC assumes it to be included in the price. In case the VAT charged is more than the VAT paid, the difference needs to be settled down with the HMRC; failure to do so might lead to penalties. However, if the VAT paid is more than the VAT charged, you can reclaim that amount from the HMRC.

VAT Rates

As you might have noticed, not every VAT is of the same type. Depending upon the type and the necessity of a product or service, the rate of VAT levied upon them differs. Broadly, there are 3 types of rates:

Standard Rate

The Standard rate of 20% is applicable to most of the products and services in the UK, only excluding those that fall under zero-rated or are VAT-exempt. To save legal troubles, it is always better to check out the list of goods and services under this category in the UK. This list is publically available and contains all the items that are eligible for the standard rate.

Reduced Rate

A certain category is made for products which are necessary enough, and a reduced rate of 5% is levied on them. This includes booster cushions, mobility aids for elderly and children's car seats. Additional services that you may provide for these products, like installation of the mobility aid in the house, will be exempted from VAT.

Zero Rate

Products which are absolutely necessary are under the category of Zero rate and no VAT is applied over them. These include books, newspapers, motorcycle helmets, children's attire etc. It must be kept in mind that even though Zero rated products have no VAT, a record of their sales still needs to be kept and reported in the VAT Return.

VAT rate must be carefully designed because it is non-refundable once paid, i.e., you cannot reclaim the money if you have paid the wrong amount. So the best approach is to gather as many details about the VAT rate as possible before you start trading:

  • Display the VAT details on the invoice.
  • Display the correct VAT amount on the VAT Return.
  • Only charge the right VAT rate on your goods and services.
  • Decide upon whether the price displayed must be including or excluding VAT.
  • Keep proper transactional records of your VAT.
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