VAT (Value Added Tax) confuses most small businesses at first. Here's what you actually need to know.

What Is VAT?

VAT is a consumption tax added to most goods and services in the UK. Currently, the standard rate is 20%.

Key point: VAT is paid by the end customer, not by you. You're just the tax collector.

How VAT Works

Without VAT:

• You sell a product for £100
• You keep £100

With VAT:

• You sell a product for £120 (£100 + 20% VAT)
• You keep £100 (your sale)
• You owe HMRC £20 (the VAT)

You're no better or worse off. The customer pays the £20 VAT, you just collect it.

When You Must Register for VAT

Mandatory: When your annual taxable turnover exceeds £85,000 (as of 2024).

Voluntary: You can register even if you're below £85,000.

Why Register Voluntarily?

Pros:

• You can reclaim VAT on business expenses
• Looks more professional
• Good if customers are VAT-registered businesses

Cons:

• More admin (VAT returns every quarter)
• 20% price increase scares off consumers
• Cash flow impact (you pay VAT before you collect it)

The VAT Calculation

Adding VAT (net to gross):

£100 × 1.20 = £120

Removing VAT (gross to net):

£120 ÷ 1.20 = £100

VAT amount: £120 - £100 = £20

Quick removal formula:

VAT = Gross × 20/120 = Gross × 0.1667

Different VAT Rates

Standard rate (20%): Most goods and services

Reduced rate (5%): Children's car seats, home energy, sanitary products

Zero rate (0%): Food, books, children's clothes, public transport

Exempt: Insurance, finance, education, health services

Zero-rated and exempt sound similar but differ for VAT reclaim purposes.

VAT on Expenses (Input VAT)

If you're VAT registered, you can reclaim VAT on business expenses.

Example:

• You buy a laptop for £600 + £120 VAT (£720 total)
• You reclaim the £120 VAT from HMRC
• Net cost to you: £600

This is why B2B businesses don't mind paying VAT—they get it back.

Common VAT Mistakes

Mistake 1: Thinking VAT is profit

VAT you collect isn't your money. It belongs to HMRC. Budget for it separately.

Mistake 2: Not adding VAT to prices

If your price is £100 and you're VAT registered, you must charge £120. Don't eat the VAT.

Mistake 3: Missing the threshold

If you cross £85,000 and don't register within 30 days, you face penalties and owe backdated VAT.

Mistake 4: Using flat rate scheme wrong

The Flat Rate Scheme simplifies VAT but isn't always beneficial. Do the math.

Should You Register?

Register if:

• You're over £85,000 (you must)
• You sell to VAT-registered businesses
• You have high VAT-able expenses to reclaim

Don't register if:

• You're well under £85,000
• Your customers are consumers (price-sensitive)
• You have low reclaimable expenses

Use our VAT Calculator to see how VAT affects your pricing.