How to work out VAT

One subject us tax accountants get asked the most is Value Added Tax (‘VAT’). What in theory should be quite a simple tax is actually really hard for many business owners to administer in practice.

In this article, we’ll cover everything from how to work out VAT to when you need to add VAT to sales and claim it back on expenses.

Key topics include:

What VAT is;
The different rates of VAT and how they affect the gross & net sales prices of the products and services you sell;
Working out your VAT bill;
How to use a VAT calculator; and
Three Black & White Accounting action plans for your business and VAT.

What is VAT?

VAT was first introduced into the UK by the government in 1973 replacing the then controversial Purchase Tax.

If a business is registered for VAT, it must then always add VAT at the applicable rate to the price at which it sells its products and services to its customers.

VAT and the price of goods and services

Generally, if a business sells to consumers, it generally displays the prices of its goods and services including (inclusive of) VAT (sometimes called the gross amount or the total price to the customer).

When a VAT-registered business is selling to another VAT-registered business or public sector organisation, it will normally advertise the prices of its products and services excluding (exclusive of) VAT (sometimes called the net amount).

In both situations however, when a consumer, business, or public sector body purchases a product or service from a VAT-registered business, the money which changes hands will always be the VAT inclusive amount.

If you’re registered for VAT, adding VAT at the standard percentage rate or whichever percentage rate applies is a legal requirement – you can’t opt out of it.

So then why the difference in how companies advertise prices depending on who they sell to?

Because when a business is registered for VAT, it can claim back the VAT on goods and services it has bought in. This means that the true price a VAT-registered customer pays is actually the VAT exclusive price.

This, of course, affects what you pay in VAT to HMRC when your bill is due. We’ll explain how you calculate your VAT bill later on in this article.

What is the current VAT rate?

The standard national rate of VAT in the UK is 20% on nearly all items sold.

Following the financial crisis of 2008-2009, the standard VAT rate was briefly reduced to 17.5%. However, on the 4 January 2011, it went back up to 20% and it has remained there ever since.

At time of writing (2021), rates are not expected to change even as the government looks for additional revenue following the COVID-19 pandemic.

How to work out VAT on goods and services

Here’s an example.

So, when adding VAT to the price you want to charge a customer, you take the base amount – say £100 – and add the standard 20% rate to that.

The VAT exclusive price (price without VAT/net amount) is £100, the VAT inclusive price (price including VAT/gross amount/total price) is £120, and the amount of VAT charged in that transaction is £20 of the price paid by the end user.

Not all products and services have the standard rate of VAT applied to their price though.

How to calculate the reduced VAT rate of 5%

There is a reduced VAT of 5% applying to a limited range of products and services like children’s car seats and gas & electricity bills.

Here’s an example of how this applies to smoking cessation products which are 5% rated.

How would you calculate the amount of VAT at the reduced VAT rate on these products?

If you wanted to sell a smoking cessation product for £10, the price you’d sell it at would have to include 5% VAT.

When calculating the VAT for this, you would divide the £10 by 1.05.

This calculation will show you the VAT exclusive price £9.52.

To determine the amount of VAT you charge, you subtract the price including VAT of £10 from the price excluding VAT of £9.52. This means that you’ve charged the customer the VAT amount of 48p on the transaction.

Working with the 0% VAT rate

There are a number of products and services to which you don’t add VAT to the price because they are zero-rated for VAT, mainly food stuffs.

How to calculate your VAT bill

When you’re registered for VAT, you normally have to pay a bill every quarter to HMRC. You have around 5 weeks to report how much you owe and to make payment in full.

To calculate your final bill, you need to do the following:

work out your output VAT (this is the total amount of VAT you’ve charged customers in the three month period)
work out your input VAT (this is what you’ve paid in VAT to your suppliers on purchases your business has made which include VAT)
Subtract 1 from 2

If the sum is positive, you owe HMRC that amount. If the sum is negative, HMRC owes you that amount.

Many businesses find that paying HMRC quarterly puts too much pressure on their cash flow. There is a monthly payment option available if that would suit you better.

However there are a number of other VAT schemes for you to choose from.

What are the different types of VAT schemes?

There are six main VAT schemes as follows:

1. Flat rate VAT scheme

Companies on the flat rate VAT scheme pay VAT differently to the example we’ve just shown above.

Unlike with the standard VAT system, you can’t claim back the VAT on your expenses (except for certain assets costing more than £2,000) with the flat rate.

Whenever you issue an invoice, you apply VAT at the applicable rate for that product or service but you then withhold a percentage of the total gross invoice value to pay to HMRC.

For example, a food manufacturer’s flat rate is 9%. On an invoice of £100 net, you’d charge your client £120 gross if this was a standard rate item. You then withhold 9% of the £120 and pay that as your VAT on the transaction.

2. Accrual accounting VAT scheme

The accrual accounting scheme is the standard VAT scheme used by almost all companies. With the accrual accounting scheme, VAT becomes due whenever:

you issue an invoice and not on when you’re paid and
you receive an invoice, not on when you pay it.

3. Cash accounting VAT scheme

The cash accounting scheme is the same as the accrual accounting scheme expect that VAT become due when your invoice have been paid rather than invoiced.

This is much better for cash flow for companies which give their clients 30 or more days to make payment on their invoices. Your turnover has to be no more than £1.35m to join the scheme.

4. Annual accounting VAT scheme

With the annual accounting scheme, you estimate the level of VAT you’ll be charging during the year. You then make payments towards your agreed bill quarterly or monthly.

At the end of the year, if you’ve overpaid, you get a refund from HMRC but, if you’ve underpaid, they’ll issue you with an invoice instead. The annual accounting scheme is best suited for seasonal businesses.

5. Retail and VAT margin schemes

For retailers, the retail scheme is designed to make the calculation of VAT simpler – there are three separate schemes you can choose from depending on how and what you sell and the size of your business.

For sellers of second-hand goods, works of art, antiques, and collectors’ items, the margin scheme is charged at 16.66% of the difference between what you paid for an item and what you sold it for.

6. Reverse charge VAT scheme

The reverse charge scheme is designed for VAT registered construction businesses. It’s pretty complicated but more can be found out here. For more information in the meantime, please call us on 0800 140 464.

VAT frequently asked questions

How do you work out VAT on a price?

To work out the VAT inclusive amount on a job you’re pricing, enter what you wish to charge into a calculator and multiply it by 1.2 (or multiply by 1.05 if on the reduced rate).

To calculate VAT separately (that is the amount of VAT you charge to your client or to remove VAT from your VAT-inclusive amount), do the same as above but then subtract the pre-VAT figure.

For example, £100 x 1.2 = £120 including VAT and (£100 x 1.2) – £100 = £20 for the actual VAT charge.

How do I calculate VAT backwards?

To calculate VAT backwards (or to remove VAT from a VAT-inclusive amount), grab a calculator. Enter the amount you wish to work out the pre-VAT figure on and divide by 1.2.

For the reduced VAT rate of 5%, enter the including-VAT figure into your calculator and divide by 1.05%.

Do you have a VAT calculator on your site?

We do have a VAT calculator on our site – please click here to visit it. This will automatically multiply or divided for you depending on the information you want.

Instructions on how to use of VAT calculator

To use our VAT calculator, please enter a figure into the “Starting Figure” box at the top of the form. Using the box below, indicate whether the figure you have entered includes VAT.

Then let our calculator know whether you are paying VAT at the standard rate or at the current hospitality and attractions rate.

Then, please press the “Calculate” button.

Our VAT calculator will then display the “net amount” (the figure excluding VAT), “the gross amount” (the figure including VAT) and the VAT figure (the difference between the net amount and the gross amount).

VAT and Coronavirus

In reaction to the current Coronavirus pandemic, the government temporarily a reduced VAT rate of VAT to 5% on certain supplies relating to:

Hospitality;
Hotel and holiday accommodation; and
Admissions to certain attractions.

i.e., many who were affected by forced closures and social distancing measures. Initially this applied from 15 July 2020 and 31 March 2021. However, the 2021 Budget changed this so:

temporary reduced rate of VAT of 5% was extended until 30 September 2021; and
prepare for a new rate of 12.5% from 1 October 2021 to 31 March 2022.

Your VAT action plan

We’ve got three VAT action plans for you depending on your current business situation.

VAT action plan for non-registered business and companies

You must register for VAT if your annual turnover is greater than £85,000 or at the time when you expect that your annual turnover for the coming 12 months will exceed £85,000.

Get in touch with Black and White Accounting and:

we’ll confirm that you’ve passed the threshold and help you register for VAT;
if you passed the threshold a long time ago and you should have registered for VAT earlier, we’ll work out the sum you likely owe HMRC and help you resolve the issue with them; and
if you have historically turned over £85,000 or less but you now think you’re likely to exceed it, let us look at your books and determine whether you’re correct. If you are, then we’ll start the process for you as your registered tax agent.

VAT action plan for companies already registered with HMRC but whose turnover has fallen

What if you are VAT registered but your turnover has fallen because of deteriorating market conditions or you’ve decided to scale back the amount of work you do? VAT deregistration is an option if your turnover falls below £85,000.

The situation can be quite confusing because HMRC state that they may charge you a penalty for not deregistering for VAT within 30 days but VAT registration is voluntary for businesses turning over less than £85,000.

Get in touch with us and let us examine your turnover to confirm that it has slipped under £85,000 and to confirm that it is likely to stay that way based on the average monthly revenue you’ve recently been generating. We can handle this entire process for you.

VAT action plan for companies already registered with HMRC

If you are already registered for VAT and you don’t want or need to deregister, we’ll check if you’re on the right VAT scheme.

We’ll go through the following checklist:

do you sell second-hand goods, works of art, antiques and collectors’ items? If so, the retail and VAT margin scheme will almost certainly be cheaper and easier to run;
should you be on the flat rate VAT scheme? You don’t save a huge amount of money but paperwork is easy in comparison to the standard scheme – let us check if you’re eligible;
are you on the cash accounting VAT scheme? If you turn over less than £1.35m a year, it’s better to move from accrual accounting to cash accounting. With accrual accounting, VAT becomes due when you issue an invoice but with cash accounting, it becomes due when you’re paid. This is much better for your cash flow;
would you prefer to pay your VAT monthly? If so, we can contact HMRC on your behalf to request that you pay your standard VAT bills monthly rather than quarterly. Alternatively, it might be better for you to join the Annual Accounting VAT scheme; and
have you claimed for everything? You may have understated your input VAT over the last four years because your expenses have not been correctly recorded and allocated in your financial records. Let us look back through your accounts and make sure that you’ve claimed on every allowable and related expense. You’ll be surprised how many companies are due a refund and by the size of some of those refunds as well. We’ll work with HMRC throughout the entire process on your behalf.

Get in touch with us and make sure to make sure that you’re on the VAT scheme which suits your business.

Working with VAT accountants

Black And White Accounting is an established accounting practice working with businesses across the UK. Getting your VAT return exactly right each time is critical.

That’s not just so that your business’ books conform to HMRC’s minimum accounting quality guidelines but so that you claim back every allowable and related expense possible to reduce the size of the VAT bills you have to pay and to help you pay on time.

Calculating your VAT using the figures in your online bookkeeping package is easy enough – calculating the correct VAT bill by making sure that your financial records are always up-to-date and accurate is one of the major benefits you get from working with an accountant. They can also help with the right software solution(s) to make the how process a lot easier.

To find out more, please get in touch with us today, by contacting Black and White Chartered Certified Accountants, populating the “Got a Question” form on the right, or calling us on 0800 140 464.

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