Understanding VAT rates and categories for small businesses

VAT is a consumption tax levied on the value added to goods and services at each stage of production or distribution.

It is compulsory to register for VAT if your business exceeds £85,000 in taxable turnover over the previous 12 months.

However, you can also choose to register for VAT, even if your business is not required to.

Standard rate

The standard rate of VAT is the most common rate applied to goods and services.

Currently, the standard rate is set at 20 per cent.

Most business services, such as consulting, marketing, accounting, legal, and IT services, fall under this standard rate category.

If your service does not qualify for a reduced or zero rate (as we'll discuss later), you are likely liable to charge your customers 20 per cent VAT.

Reduced rate

Certain services qualify for a reduced VAT rate in the UK.

The reduced rate is 5 per cent.

Services like energy-saving measures, children's car seats, and some specific renovation work on residential properties fall under this category.

If you provide any services eligible for the reduced rate, charging your customers at 5 per cent VAT is mandatory to remain compliant.

Zero rate

While it may sound counterintuitive, some services are categorised as "zero-rated" for VAT purposes.

This means that while you still need to account for VAT on your invoices, the rate charged is 0 per cent, resulting in no additional cost to your customers.

Zero-rated services in the UK include exports of services outside the EU, certain medical and educational services, and books, newspapers, and magazines (both printed and digital versions).

Keep in mind that even though the rate is 0 per cent, it's crucial to correctly record and report zero-rated transactions in your VAT returns.

Exempt supplies

Exempt supplies differ from zero-rated supplies in that they are not subject to VAT at all.

This means you do not charge VAT on these services, but you also cannot claim VAT on related expenses.

Examples of exempt services are healthcare services provided by doctors and dentists, education provided by eligible institutions, and insurance services.

As a business service provider dealing with exempt supplies, it's crucial to keep these transactions separate from your VAT-liable services to maintain accurate records.

Mixed supplies

In some cases, you may find that your business provides a combination of standard-rated, reduced-rated, zero-rated, and exempt services.

These are known as "mixed supplies."

When dealing with mixed supplies, it's essential to apportion the VAT correctly for each type of service provided.

This can get complex, so seeking professional advice or utilising specialised accounting software can help ensure accurate calculations.

For more advice on VAT rates and how they apply to your business, get in touch.