VAT Rules & Regulations: Basics & Insights

Understanding how VAT works in practice can make the concept clearer for both businesses and consumers. 

VAT, or Value Added Tax, is applied at different stages of production and sale, affecting prices and business accounting. Many people wonder how it appears on invoices and who ultimately pays it. 

In this article, you can discover answers to questions including “What does VAT mean, “How does VAT work?”, and “What does VAT registered mean?”. You can also see straightforward examples explaining how VAT is calculated and processed in typical transactions.

What Is VAT?

What does VAT stand for, and what is VAT’s meaning? Value Added Tax (VAT) is a type of consumption tax applied to most goods and services.

It’s charged at each stage of the supply chain where value is added, from production to the point of sale.

Unlike sales tax, which is only paid by the final consumer, VAT is collected by businesses throughout the supply process.

Each business in the chain pays VAT on purchases and collects VAT from customers, then submits the difference to the tax authorities.

VAT is:

• Applied to the value added at each stage of production and distribution
• Collected and remitted by registered businesses
• The end consumer ultimately bears the full cost

So, what is VAT in the UK? In the United Kingdom, the standard VAT rate is 20%.

Some goods and services may have reduced or zero rates, depending on government regulations.

Example of VAT calculation:

Businesses must register for VAT if their taxable turnover exceeds a certain threshold set by HMRC. Registered businesses can reclaim the VAT they pay on business purchases.

VAT is one of the main sources of government revenue in many countries, including the UK. The system aims to tax consumption, rather than income or production.

Who Needs to Register for VAT in the UK?

A business must register for VAT if its VAT taxable turnover exceeds the registration threshold.

As of 2025, this threshold is £90,000 over any rolling 12-month period.

Registration must also be completed if:

• The business expects its taxable turnover to go over £90,000 in the next 30 days alone.
• The business is based outside the UK but supplies goods or services to the UK.

The term taxable turnover refers to the total value of sales that are subject to VAT, not just profit or income.

This includes standard, reduced, and zero-rated VAT supplies, but not VAT-exempt sales.

The compulsory VAT registration triggers are:

Businesses that don’t exceed the threshold can still register voluntarily. This is sometimes preferred for reclaiming VAT on purchases or for business image reasons.

They must keep track of their turnover every month to make sure they don’t miss the registration deadline.

Failure to register on time can lead to penalties and back-dated VAT charges.

5 Types of VAT Schemes

Businesses in the UK can choose from several VAT schemes to simplify accounting and reporting.

Each scheme has specific rules and benefits depending on the size and nature of the business. The five types of VAT schemes are as follows.

1. The Flat Rate Scheme

This scheme allows businesses to pay a fixed percentage of their turnover as VAT. The exact percentage depends on the type of business.

It’s designed to make VAT calculations easier, especially for small businesses.

2. Cash Accounting Scheme

With the cash accounting scheme, businesses pay VAT to HMRC only when their customers pay them.

They can also reclaim VAT on purchases only when they make a payment to their suppliers. This helps with cash flow management.

3. Annual Accounting Scheme

The annual accounting scheme reduces the number of VAT returns from four to just one per year.

Businesses make advance payments towards their VAT bill in instalments.

It’s particularly helpful for those who prefer simpler and less frequent reporting.

4. VAT Retail Schemes

Retail schemes are designed for businesses making a high volume of retail sales to the public.

They offer methods to calculate the VAT due, such as the point of sale, apportionment, or direct calculation methods.

5. VAT Margin Scheme

The VAT margin scheme allows certain businesses, like second-hand goods or art dealers, to pay VAT only on the difference between the purchase and sale price of goods.

This method avoids charging VAT on the full selling price, reflecting only the margin made.

Adding VAT to Invoices

When a business is VAT registered, it must add VAT to the invoices issued to customers.

The invoice must clearly state the VAT amount so customers can reclaim it if they’re also VAT registered.

The correct VAT rate depends on the goods or services provided.

In the UK, common VAT rates are 20% (standard), 5% (reduced), and 0% (zero-rated). To calculate these rates:

• Multiply the net amount by 1.20 for the 20% rate.
• Multiply by 1.05 for the 5% rate.

For example:

Each invoice must include:

• The business’s VAT number.
• The VAT rate applied.
• The total VAT charged.
• A breakdown of each item and its VAT amount.

Invalid or missing VAT information can make the invoice non-compliant with HMRC requirements.

Always double-check figures and details to ensure accuracy.

VAT-Inclusive Vs VAT-Exclusive Prices

Prices can either be inclusive of VAT or exclusive. 

VAT-inclusive

VAT-inclusive prices show the total amount a customer will pay, with VAT already added to the price of the goods or services.

This means the VAT component is included in the displayed amount.

For example, if a shirt is advertised at £24 (VAT-inclusive), this is the actual price to be paid at the till. The included VAT is not added on top at checkout.

VAT-exclusive

VAT-exclusive prices list the cost of goods or services before VAT is added.

Businesses often use this method when selling to other VAT-registered companies, as these buyers can reclaim input VAT.

If a product is £20 (VAT-exclusive) and the VAT rate is 20%, the total to be paid becomes £24 (£20 + £4 VAT).

Below is a table comparing VAT-inclusive prices and VAT-exclusive prices:

Consumers benefit from VAT-inclusive pricing, as it’s clear and straightforward.

Businesses often see VAT-exclusive prices, especially on invoices, because it helps track reclaimable VAT.

Making Tax Digital for VAT

Making Tax Digital (MTD) is a UK Government initiative introduced to modernise the way VAT is recorded and reported.

It requires businesses to keep digital VAT records and submit VAT returns using compatible software.

Since April 2022, all VAT-registered businesses have needed to comply with MTD rules, regardless of their turnover.

HMRC now automatically enrols new VAT-registered businesses into the MTD scheme unless an exemption applies.

The scheme requires that businesses:

• Maintain digital VAT records
• Use HMRC-approved, compatible software for submissions
• Keep all VAT accounting data digitally
• Link digital records using digital links (spreadsheets allowed with appropriate bridging software)

Businesses no longer need to sign up themselves if they register for VAT, as this process is handled by HMRC.

The aim of MTD is to reduce errors and make tax compliance easier.

Businesses must update their software and ensure employees are trained on the new digital processes.

Exemptions are available for those who cannot use digital tools due to age, disability, or location. To apply for exemption, businesses need to contact HMRC directly.

Here’s a sample comparison of the old and new approaches:

When Can VAT Be Reclaimed?

A business can reclaim VAT when it’s registered for VAT and has purchased goods or services used for its taxable business activities. This includes items bought from other VAT-registered suppliers in the UK or imported from abroad.

To reclaim VAT, valid documentation is required. This usually means a VAT invoice that clearly shows the VAT amount paid.

Without this, it’s not possible to claim the VAT back.

VAT can be reclaimed on most business expenses, such as equipment, stock, and utility bills. However, ineligible items include most business entertainment costs and goods bought for personal use.

Time Limit for VAT Reclaims

Businesses can usually reclaim VAT up to four years from the due date of the original VAT return. Claims made outside this period are generally not accepted by HMRC.

Common Eligibility Requirements for VAT Claims

To reclaim VAT, the business and the supplier need to be VAT-registered. The goods or services must have been bought for business purposes, and a valid VAT invoice must be available.

The business must include the reclaim as part of its regular VAT return. This is submitted to HMRC, typically every three months.

Key Takeaways

In conclusion, VAT is a consumption tax applied at each stage of the supply chain, and businesses must register for VAT if their taxable turnover exceeds £90,000. 

There are several VAT schemes available, such as the Flat Rate and Cash Accounting schemes, which can simplify reporting and payment. 

Businesses can reclaim VAT on eligible purchases, provided they have valid invoices, but must be careful with record-keeping to ensure compliance with Making Tax Digital (MTD) rules. 

Staying informed about the VAT rates, exemptions, and sector-specific regulations is crucial for avoiding penalties and optimising VAT recovery.