There used to be a joke about getting a straight answer out of certain tradespeople; they’d suck air over their teeth and say “Well it depends!” and by the time you got round to pinning them down and asking exactly how much it would cost the answer would be something like “Ninety-five pounds… plus VAT”.

VAT has been with us in one way or another for over 75 years. In 1940, “Purchase Tax” was introduced on ‘luxurious’ items at the confusing level of 33¹/₃% and rose to 100% a few years later. Purchase Tax wasn’t paid by customers when they bought items, but by the manufacturers and distributors.  In 1973, when the UK joined the EU, Purchase Tax was replaced by Value Added Tax, which was paid by customers every time they bought certain items as opposed to being charged to businesses.

It doesn’t really help to say what VAT is, however. Other countries call it General Sales Tax and all it means is that a percentage of tax is added onto the top of many goods and services. If you call out a plumber who charges £100 for his time, once UK VAT at 20% is taken into account, you’d pay him £120 and the plumber would pass the extra £20 onto HMRC.

If you’re working as a business in the UK, once you start to earn £85,000 a year, you must register for VAT – if you’re involved in distance selling into the UK, the threshold is £70,000. This means that all of your sales, whether it’s goods or services must have an extra 20% added to them that you pay to HMRC. VAT also applies to hiring or loaning goods, selling business assets and commission. Many businesses choose to register for VAT before they hit the £85,000 threshold but it’s important to note that if you do register, you must charge VAT on all applicable sales. If you’re not registered, you cannot charge VAT on your invoices.

Most goods and services in the UK need to charge 20% VAT, but there are reduced rates of 5% for home gas and electricity supply or child car seats. More essential items are either exempt or have a zero-rate VAT cost, such as motorcycle helmets, insurance or children’s clothing and shoes. Unless you’re involved in selling these particular exempt items, once you register for VAT, you’ll need to add 20% to all your invoices.

If you’re a VAT registered business, then you (or your accountant) must report a VAT return to HMRC every three months. If you’re a business that pays VAT, then if you’ve charged more VAT to your customers than you’ve paid to other businesses, then you hand over the difference. Rather nicely, if you’ve paid more VAT to others than you’ve taken yourself, then you get to claim the difference back from The Taxman!

VAT is a complicated bit of tax law, but the principle is quite simple, everyone who buys certain goods and services must pay 20% tax over the cost of their item and it’s up to the business that sells it to pass on that tax to HMRC. There’s also Flat Rate VAT, which we’ll cover in another blog – so make sure to come back soon!

Photo credit: P T Money