A brief introduction to VAT

Value Added Tax or ‘VAT’ is a tax that’s based on the value of goods or services. It’s important to understand how VAT works as part of running a small business, so we’ve put together this simple guide to get you up to speed on the basics.

How does UK VAT work?

VAT is a tax on sales in the UK. If a business is registered for VAT, then it has to charge VAT on all its taxable sales - this is called output VAT. The business is also entitled to claim back most (but not all) of the VAT that it’s charged by its suppliers - this is called input VAT.

Making Tax Digital (MTD) for VAT is here

Making Tax Digital (MTD) was introduced in 2019. It first required certain VAT-registered businesses to keep digital tax records and use MTD-compatible software to submit their VAT returns electronically.

The scope of Making Tax Digital for VAT expanded on 1st April 2022 and all VAT-registered businesses are now required to follow these rules.

Find out more on HMRC’s website.

Should you be registered for VAT?

If your business’s annual VATable sales go over the VAT threshold set by HMRC in a 12-month period or you expect to exceed the threshold in the next 30 days, you need to register your business for VAT. This is why you should check your VATable sales regularly!

The registration threshold usually changes every year and is £90,000 of VATable sales (as of 1st April 2024). While the VATable sales limit is the main factor in determining eligibility for VAT registration, there are others included in HMRC’s guide on when to register.

You can usually register for VAT even if your VATable sales are below the threshold. However, if your business only makes VAT exempt sales, then you can’t register for VAT.

The majority of businesses register for VAT online and get set up to submit VAT returns digitally using accounting software, although some choose to appoint an accountant to submit VAT returns on their behalf.

What are VAT "exempt sales"?

Most goods and services sold in the UK are subject to VAT. However, some - such as stamps, insurance and education - are exempt from VAT. This means that if you're a home tutor who sells nothing but your teaching services, for example, you'll never have to register for VAT because your business will only ever make exempt sales. Find out more about exempt sales in our comprehensive guide to the different VAT rates.

When should you register for VAT?

If your customers aren't registered for VAT, they won't be able to claim back input VAT on the goods and services they buy from you. As a result, your business becoming VAT-registered effectively represents a price increase to them. If your customers are members of the general public or are small businesses who might not have registered for VAT yet, then you may prefer to wait to register until you reach the threshold.

When do you have to pay VAT?

Owners of VAT-registered businesses are required to submit VAT returns to HMRC to declare how much VAT they need to pay.

VAT returns are filed quarterly to HMRC in most cases, and both the return and accompanying VAT bill usually need to be submitted and paid within 37 days of the end of each quarter. This means a VAT return and bill for the quarter ending 31st March would need to be filed and paid by 7th May.

What happens if you can’t pay your VAT bill?

If you don’t pay your VAT on time, you may find yourself subject to tax investigations and you could incur interest and penalties, so you should contact HMRC as soon as possible if you’re having trouble paying your VAT bill.

There are a few options available for business owners who cannot pay their VAT, including:

  • a ‘Time to Pay’ arrangement with HMRC, which may allow business owners to pay their VAT in instalments over a period of 12 months
  • entering administration
  • closure options such as a Company Voluntary Arrangement

VAT calculator

To help you work out the amount of VAT you should charge your clients in the easiest possible way check out our VAT calculator.

Disclaimer: The content included in this guide is based on our understanding of tax law at the time of publication. It may be subject to change and may not be applicable to your circumstances, so should not be relied upon. You are responsible for complying with tax law and should seek independent advice if you require further information about the content included in this guide. If you don't have an accountant, take a look at our directory to find a FreeAgent Practice Partner based in your local area.