Add or remove VAT at 20%, 5%, or zero rate. Then understand the rules that actually matter.
Value Added Tax is collected at every stage of production — but only the consumer ultimately pays it. Businesses are unpaid collection agents for HMRC.
The mechanism is simpler than it sounds. A manufacturer adds 20% VAT when selling to a wholesaler. The wholesaler pays that VAT, but later claims it back when filing their own VAT return. They charge VAT on their sale to the retailer. The retailer reclaims that, charges VAT to the end customer, and the final consumer — who isn't VAT-registered — absorbs the cost with no way to recover it.
That chain of collection and reclaim is why VAT-registered businesses aren't really "paying" VAT at each stage. They're passing it through. The net amount they owe HMRC is output VAT (charged on sales) minus input VAT (paid on purchases). A business with £20,000 in output VAT and £7,000 in input VAT owes £13,000 on that quarter's return.
Output VAT is what you charge your customers. Input VAT is what you pay to your suppliers. Your VAT return is the reconciliation between those two numbers. When input exceeds output — common for businesses with large supply costs or for exporters — HMRC owes you a refund.
This is why voluntary VAT registration can make financial sense even below the £90,000 threshold. A freelance designer who buys expensive software, hardware, and office space is paying 20% VAT on those purchases. If they're registered, they reclaim it. If they're not, it's an unavoidable overhead that eats into margin.
The UK uses four tiers. The distinctions between zero-rated and exempt are particularly important — they behave differently in the VAT system.
| Rate | Category | Common examples | Can reclaim input VAT? |
|---|---|---|---|
| 20% | Standard | Electronics, clothing, restaurant meals, professional services, most B2B services | Yes |
| 5% | Reduced | Home energy (gas & electricity), children's car seats, nicotine patches, sanitary products, mobility aids for elderly | Yes |
| 0% | Zero-rated | Most food & drink, children's clothing, books & newspapers, prescription medicine, public transport, exports | Yes |
| — | Exempt | Insurance, financial services, education, postage stamps, land and property (unless opted to tax), health services | No |
Food is mostly zero-rated — except when it's "hot food" or consumed on the premises of a catering establishment, in which case it becomes standard-rated. An identical sandwich is zero-rated in a supermarket and 20% in a café. Same product, very different VAT treatment.
Construction is another area full of nuance. New residential builds are zero-rated. Renovations and repairs on existing homes are standard-rated. Converting a non-residential property to residential can be reduced-rated. If you're in the trades, getting this wrong on every invoice compounds into a meaningful error over a year.
Digital services sold to UK consumers always attract 20% VAT, regardless of where the seller is based. That's been HMRC policy since 2015 and the rules were tightened post-Brexit. An overseas software company with UK consumer revenue above £90,000 must register here.
Three situations come up constantly. The formula for each is simple once you understand what each variable represents.
You have a price before VAT and need to find the customer-facing total. Multiply the net amount by 1 plus the rate as a decimal:
You have a VAT-inclusive price and need to find the net amount. This is where most people make an error. You cannot simply subtract 20% from the gross — that gives the wrong answer.
If you only need the tax component without working through net, at the standard 20% rate there's a shortcut: the VAT is always one-sixth of the gross amount. Divide by 6.
This error appears on handwritten invoices, in spreadsheets with the wrong formula, and occasionally on supplier invoices themselves. Catching it before it compounds across a VAT period is one of the easiest ways to protect margin. The reverse calculator above handles it correctly every time.
Unchanged since April 2024. Applies to any rolling 12-month period — not the tax year.
The threshold works on a rolling 12-month basis, not a tax year. At the end of every calendar month, you look at the previous 12 months' taxable turnover. If it exceeds £90,000, you have 30 days from the end of that month to notify HMRC. Your effective VAT registration date is then the first day of the following month.
There's also a forward-looking test. If you have reasonable grounds to believe your taxable turnover will exceed £90,000 in the next 30 days alone — perhaps you've just signed a large contract — you must register immediately, and the registration takes effect from the start of that 30-day period. This catches businesses that complete a single high-value project that would breach the threshold in one shot.
Taxable turnover includes all standard-rated, reduced-rated, and zero-rated sales. It does not include exempt sales. A bookkeeper who also earns rental income on a residential property adds only the bookkeeping fees to their taxable turnover, not the rent — residential lettings are exempt.
The deregistration threshold sits at £88,000 — £2,000 below registration. If your turnover drops and you want to deregister, you need to demonstrate that the next 12 months will be below £88,000. The gap exists to prevent constant registering and deregistering as turnover fluctuates around the line.
Below £90,000, registration is a choice. It makes clear sense if your customers are mostly VAT-registered businesses — they reclaim whatever VAT you add, so it costs them nothing, and you gain the ability to reclaim your own input VAT. A freelancer paying 20% VAT on a £3,000 MacBook Pro recovers £500 the next time they file a return.
It makes less sense if most of your customers are private individuals. You'd effectively be adding 20% to your prices, either absorbing the cost yourself or passing it on and becoming less competitive. Some creative freelancers and tradespeople in consumer markets stay deliberately below the threshold for exactly this reason.
HMRC designed the Flat Rate Scheme (FRS) to simplify bookkeeping for small businesses. Instead of tracking input and output VAT on every transaction, you pay a fixed percentage of your gross (VAT-inclusive) turnover. The percentages vary by sector and are published by HMRC.
You still charge your customers 20% VAT as normal. The difference is what you pay to HMRC — which can be less than what you collected. That difference is yours to keep.
In 2017 HMRC introduced the "limited cost trader" category at 16.5% to close a loophole where service businesses with almost no goods costs were profiting heavily from the scheme. If your goods expenditure in a quarter is less than either 2% of your VAT-inclusive turnover or £1,000, you're a limited cost trader and must use 16.5%.
At 16.5%, the scheme rarely saves money. You'd pay 16.5% of gross vs HMRC's take of ~16.67% of net under standard accounting — effectively identical. If you're caught by the limited cost trader rule, you're better off staying on the standard scheme and at least recovering input VAT on business purchases.
The FRS exit threshold is £230,000 VAT-inclusive turnover. Once you exceed that, you must leave the scheme. The £150,000 eligibility threshold (VAT-exclusive) applies on joining. You can use the calculator tab above to estimate your FRS payment for any sector.
They behave entirely differently. Zero-rated sales count towards your taxable turnover (pushing you towards the £90,000 threshold) and allow you to reclaim input VAT on related costs. Exempt sales don't count towards turnover, but they also block input VAT recovery on costs directly related to those exempt supplies. A business with mixed supplies faces partial exemption calculations — and getting the proportion wrong means either overpaying or underpaying VAT.
HMRC charges penalties on the VAT that should have been collected from the date you should have registered — not from when you actually did. Miss the threshold by a year while billing unregistered, and you could owe 20% on a year's invoices that you didn't collect from clients. It's a liability that comes out of your own pocket if the clients have long since paid and moved on.
You can only recover VAT on purchases that are "wholly and exclusively" for business purposes. A laptop used partly personally is subject to a partial restriction. Business entertainment (client dinners, hospitality) is entirely blocked from input VAT recovery under UK rules, with no exceptions. This is one of HMRC's most common targets in VAT inspections.
New residential builds are zero-rated. Renovations on existing homes are 20%. Conversions from commercial to residential can be 5%. Getting this wrong on a large construction project is a significant error. Always reference HMRC Notice 708 for construction VAT rules before raising an invoice.
VAT is calculated on the discounted price — not the original price. If you offer a prompt payment discount (say, 2% for payment within 10 days), and the customer takes it, VAT should have been charged on the discounted amount. HMRC allows a VAT credit note to correct this, but it creates an administrative burden that surprises smaller businesses when HMRC first queries it.
Since March 2021, the Construction Industry Scheme's Domestic Reverse Charge means subcontractors don't charge VAT to their main contractor — the main contractor accounts for it instead. This catches tradespeople who bill as subcontractors without knowing the rule applies. If you supply construction services reported under CIS to a VAT-registered contractor, you likely shouldn't be adding VAT to your invoice at all.
Three formulas cover every scenario. Assuming your net amount is in cell B2 and your VAT rate (as a percentage, e.g. 20) is in cell C2:
For a VAT-compliant invoice template in Excel, you'll want a separate column for net, a column for the VAT amount calculated from the net, and a gross total. Keep the rate in a named cell so you can change it from one place if reduced-rate items appear on the same sheet.
Since April 2022, MTD for VAT is mandatory for all VAT-registered businesses without exception. You must keep digital VAT records and submit returns using MTD-compatible software. HMRC no longer accepts manual submissions through the old Government Gateway VAT return portal.
Compatible software falls into two categories: full accounting software (Xero, QuickBooks, FreeAgent, Sage, Kashflow) and bridging software for businesses that want to keep their existing spreadsheet workflow. Bridging software — products like VT Accounts or Absolute VAT Filer — reads your spreadsheet data and transmits it to HMRC in the required format.
The record-keeping requirements include keeping digital records of: the time of supply, the value of supply, the VAT rate charged, and details of input VAT. Invoices and receipts must be retained digitally for at least 6 years. Paper records are no longer sufficient on their own.