How to charge and reclaim VAT
We previously delved into the world of VAT, or Value Added Tax, taking a look at how startups can register for VAT. But what happens after? How does it work in practice? Who do you charge, how much, and what can you claim back? Here's our guide.
First off – once you’re VAT registered, you’ll need to start including your VAT number on all your invoices, and you’ll need to ensure that all your invoicing now reflects the additional tax charged to your customers.
How much tax you charge depends on what you’re selling. For example, some things are tax exempt; some things are zero-rated (which isn’t the same, but VAT isn’t charged); some things are charged at a reduced rate of tax of 5%; and the standard VAT rate currently is 20%. You can find out what VAT applies to what items here.
Input and output VAT
VAT isn’t a tax on your profits; it’s a tax paid by customers, and sometimes - when buying supplies to create your product or service - you are the customer. Think of it as a food chain.
Any VAT paid by businesses on their purchases is called input VAT. Vat charged by businesses to their customers is called output VAT. And the difference between the output VAT and the input VAT that you can reclaim is the amount you hand over to HMRC quarterly.
Confusing? Here’s an example:
You're a boutique selling a dress with a baseline £60, to which you add 20% (the standard VAT rate). The dress goes on sale for £72, £12 of which is VAT that your customer pays – output VAT.
You originally bought the dress from a supplier for £24 - £20 baseline price, plus £4 output VAT.
The supplier that sold you the dress bought the original fabric and other materials for £8, plus £1.60 output VAT.
Who pays what?
So the difference between the output VAT and input VAT for the fabric seller is £1.60 less £0 = £1.60 paid to HRMC.
The difference between the output VAT and input VAT for the dress supplier is £4 less £1.60 = £2.40 paid to HRMC.
The difference between the output VAT and the input VAT for the boutique, then, is £12 less £4 = £8 paid to HRMC.
This totals £12 to HRMC in the end – the amount of VAT on the finished item, just spread out across the supply chain.
To reclaim the VAT you’ve paid on your business expenditure, you need a valid VAT invoice for the expense. This needs to include:
- Supplier’s name and address
- Supplier’s invoice number
- Supplier’s VAT registration number
- Details of the product or service supplied
- Total cost excluding VAT
- Amount of VAT charged
To claim, log into your HMRC account online to see any VAT refunds that you’re owed, and claim by submitting your VAT return online. You should get your refund within 10 days.
What can’t you reclaim VAT for?
If a purchase is for personal and business use – such as a phone contract that you use at home and for work – you can only claim VAT back on the business portion.
You also can’t reclaim VAT for:
- Things for private use
- Business entertainment costs
- Goods and services your business uses to make VAT-exempt products
- Anything you’ve bought from other EU countries, though you might be able to reclaim the VAT charged under the electronic cross-border refund system – check to see if you are eligible
- Goods sold to you under VAT second-hand margin schemes (which means taxing the difference between what you paid for an item and what you sold it for, instead of the full selling price – you pay VAT at 16.67% on the difference and it applies to second-hand goods)
However (good news!) you may be able to reclaim VAT paid on goods and services bought before you registered for VAT – but time limits apply. The limits are 4 years for goods you still have or which were used to make goods you still use; and 6 months for services.