VAT explained: what it is and how it works

As your business grows, you might need to register for Value Added Tax (VAT). If you do, it’s important to understand how to manage VAT for your small business and how to calculate your VAT return. This guide explains all you need to know.

If you run your own business, make sure you understand when you need to register for VAT and how to submit your VAT return.

What is VAT?

VAT stands for value-added tax and it applies to most goods and services in the UK. It’s an indirect tax, as businesses collect it on the government’s behalf by adding VAT to the price of their goods and services. 

Some businesses must legally register for VAT, while others can choose to do so voluntarily. 

Registering for VAT means you must charge VAT on the products and services you sell and pay this to HMRC, , usually every quarter. However, you can also reclaim VAT on goods and services your business buys, making them cheaper than if you weren’t VAT registered. 

Read more: Business tax explained

What are the different VAT rates?

There are three VAT rates in the UK, as outlined below:

• Standard rate of 20%: This applies to most goods and services.

• Reduced rate of 5%: This applies to some goods and services, such as home energy and children’s car seats.

• Zero rate of 0%: This applies to most foods, books and children’s clothes. 

Do I need to register my business for VAT?

You must register your business for VAT if your taxable turnover exceeds the VAT threshold of £90,000. This increased from £85,000 in April 2024.

Your taxable turnover is the total value of everything your business sells that’s not exempt from VAT. The threshold applies on a rolling 12-month basis, rather than a fixed period such as the tax year. 

If your taxable turnover exceeds the £90,000 threshold at any point over 12 months, you must register for VAT within 30 days. You must also do this if you expect your taxable turnover to go over this limit within the next 30 days. Failure to do so can result in penalties. 

If you don’t meet this threshold, there is no legal obligation to register your business for VAT. However, you can register voluntarily. Weigh the pros and cons to decide if this is right for your business.

What are the pros and cons of registering for VAT?

Pros

• If you buy large quantities of goods from suppliers that charge VAT, you’ll be able to claim this back against the VAT your own business charges

• Your goods and services may be more attractive to other businesses because they can reclaim the VAT they pay

• Being VAT-registered can make your business appear more credible and trustworthy

Cons

• There’s more admin involved as you need to submit quarterly VAT returns

• You need to charge VAT on your taxable goods, which means they’ll be more expensive (unless you reduce your margins)

• If the amount of VAT you need to pay outweighs the amount you can claim back, you could end up with a hefty tax bill

How to register for VAT

Before you register for VAT, make sure you have the following details to hand:

• Your company registration number (if you’re a limited company)

• Your National Insurance number and an identity document (if you’re registering as an individual or partnership)

• Your business bank account details

• Your Unique Taxpayer Reference (UTR), if you have one

• Details of your annual turnover

You can then register for VAT through GOV.UK To do this, you need a Government Gateway user ID and password. If you don’t already have one, you must create one when you sign in.

Once registered, you receive a 9-digit VAT registration number which you must include on all invoices you raise. You also receive details on how to set up your business tax account and information about when to submit your first VAT return and payment. 

How to charge VAT

How you charge VAT depends on your business type. If you’re a retailer, VAT is usually automatically included in the product’s price tag. For other businesses, you might include a separate line for VAT on your invoice, and the customer then pays both the product/service fee and VAT.

To calculate VAT, you multiply your price by 1.05 for a 5% VAT rate or 1.2 for a 20% VAT rate. You keep the price as it is for a zero VAT rate.

For example, if something costs £50 and you need to add the standard VAT rate of 20%, this would be £50 x 1.2 = £60.

How to submit your VAT return

VAT-registered businesses must sign up to Making Tax Digital (MTD) and use compatible accounting software, such as Xero, Sage or QuickBooks, to complete their VAT return and submit it online to HMRC. Alternatively, an accountant or agent could do this on your behalf. Keeping digital records can reduce the risk of mistakes. 

You must usually submit your VAT return one month and seven days after the end of an accounting period. As this occurs every three months, you need to complete a VAT return each quarter. 

Your return shows the VAT you’ve collected on sales and the VAT paid on purchases. If you’ve collected more VAT than you’ve paid, you must pay the difference to HMRC. On the other hand, if you’ve paid more VAT on purchases than you’ve collected, you can reclaim the difference. HMRC usually repays this within 30 days.

Example:

• The total VAT you’ve collected (your output VAT) is £4,000

• The total VAT you’ve paid (your input VAT) is £2,500

• You deduct £2,500 from £4,000, leaving you with £1,500 to pay to HMRC

Alternatively, if your output VAT was £2,500 and your input VAT was £4,000, you could reclaim £1,500 from HMRC.

Should I register for VAT?

If you exceed the VAT threshold in any 12-month period, you must register for VAT. However, if your taxable turnover is under this limit, you might want to consider registering voluntarily. Whether this is suitable for your business likely depends on the type of business you run. 

One of the biggest advantages of registering is you can claim back the VAT you pay on items you buy for your business. This is particularly beneficial for businesses that buy large quantities of goods from suppliers charging VAT.  

Registering for VAT also makes your business look more credible and trustworthy to clients and investors, and it might even encourage partnerships with other VAT-registered businesses.

However, if you decide to register for VAT, prepare yourself for more paperwork – it’s important to keep accurate records and you must submit quarterly VAT returns.

You must also remember to pay your tax on time. What’s more, if the amount of VAT you need to pay outweighs the amount you can claim back, you could end up with an expensive tax bill to pay.

If you don’t legally need to register your business for VAT, it’s crucial to weigh up the pros and cons of being VAT registered before proceeding. It can also be worth seeking advice from a tax advisor or accountant.

What to do if being VAT registered is killing your business

If your business is struggling because of tax, it's best to speak to an accountant who can advise you on the types of tax relief your business could qualify for to help you save money.

It’s also sensible to plan ahead and set aside a percentage of your monthly turnover, perhaps in a separate bank account, to help you pay your tax bills when they’re due.

In some cases, it might be possible to deregister from VAT. But to do this, your business needs to be under the VAT deregistration threshold of £90,000. You must also cancel your registration if you cease to trade or make VAT-liable supplies, or if you join a VAT group.

You need to log on to your online account to cancel your registration. Once deregistered, you should receive a confirmation from HMRC within three weeks of the request being made.

Once your registration has been cancelled, you’ll need to submit a final VAT return for the period up to and including the cancellation date.

This content is for informational purposes and it's not intended as financial or professional advice. Please talk to a qualified professional for guidance relating to your business' needs.