Creating a supportive business environment for SMEs
A HM Customs & Excise case study

Page 4: What is VAT?

VAT was introduced as an indirect tax into the UK in 1973 to replace Purchase Tax and Selective Employment Tax. VAT is a tax on the final consumption of goods and services, collected at every stage of production and distribution.

All EC Member States are required to implement VAT in line with the provisions of the Sixth Directive. The UK introduced VAT in 1972 when it joined the European Community (VAT replaced Purchase Tax and Selective Employment Tax.) The current VAT threshold is £54,000. This means that if a business organisation either makes a supply of goods or services or is paid for supplying goods and services above this amount, they have to register for VAT. Once registered an organisation is issued with a VAT registration number that must be quoted on all of its invoices.

There are three rates of VAT:

  • a standard rate, currently at 17.5%
  • a reduced rate of 5% on domestic fuel and power and on the installation of energy saving materials
  • a zero rate (nil) on certain essential items such as most food products and children's clothes.

VAT is a value added tax, so the only tax paid is on the value added by the organisation. This means that those who are registered for VAT must pay to HM Customs & Excise the amount they have collected (levied by them on their sales or output), less the amount of VAT that has been charged to them on the taxable supplies of goods or services bought in.Conversely, if the amount of VAT paid has exceeded the VAT collected, the organisation can claim a refund from HM Customs & Excise.

For example, if a manufacturer sells goods for £100 to a small business, £17.50 will be added to the invoice price, so that the final amount paid will be £117.50. If the small business sells the goods on for £150.00, they will in turn add £26.25 to their customer. The VAT paid by the small business will be £8.75, comprising £26.25 (output tax) less £17.50 (input tax). The amount paid is therefore simply based upon the value added created through the transaction.

VAT registered businesses keep a VAT account as part of their records. This account records the VAT paid on inputs (purchases of goods or services), and the VAT collected on outputs (sales). This account forms the basis for filling in a Value Added Tax Return.

HM Customs & Excise | Creating a supportive business environment for SMEs


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