A UK business must register for VAT when its taxable turnover goes over £90,000 in any rolling 12 months, or when it expects to pass that figure in the next 30 days alone. Once registered you charge VAT on your taxable sales, usually at the standard 20%, reclaim the VAT on your business purchases, and pay the difference to HMRC on a VAT return. Below the threshold registration is optional, and the right choice depends mainly on who your customers are.
Note: this is general information, not tax or accounting advice. VAT has many special cases, and thresholds and schemes change. Check GOV.UK, or ask an accountant, before registering, choosing a scheme or setting prices.
What VAT is, and why a small business collects it
Value Added Tax is a tax on the sale of most goods and services. It is charged at each stage of a supply chain, but the final cost falls on the end customer, because every VAT-registered business in the chain can reclaim the VAT it paid on its purchases. Your role, once registered, is that of a collector. You add VAT to your prices, hold it, and hand over what you owe after deducting the VAT on your own business costs.
This has a practical consequence. The VAT you collect is not income. If you invoice £1,200 including £200 of VAT, only £1,000 is yours, and the £200 belongs to HMRC less any VAT you have paid on costs. A business that spends the VAT it has collected can face a bill it cannot pay, so many small firms keep VAT in a separate account.
The basic mechanics are covered in VAT explained: adding and removing VAT, which also shows how to add VAT to a net price and take it out of a gross price. This guide focuses on the decisions a small business faces: when to register, how to price, what to charge and which scheme to use.
The three VAT rates and the two ways a sale can be outside VAT
The UK has three rates for VAT-able sales:
- Standard rate, 20%. Most goods and services.
- Reduced rate, 5%. A limited list, such as domestic fuel and power.
- Zero rate, 0%. For example most food and children’s clothes. These sales are still “taxable” with VAT at 0%, which matters for the registration threshold and for reclaiming VAT on costs.
Some sales are outside VAT in other ways. Exempt supplies, such as certain financial and insurance services and some education, do not have VAT charged and generally do not let you reclaim the VAT on related costs. Outside the scope items, such as wages and some payments, are not VAT-able at all. The difference between zero-rated and exempt is important: a zero-rated business can reclaim VAT on its costs, while an exempt business usually cannot, and exempt sales do not count towards the registration threshold in the same way as taxable sales. Check HMRC’s guidance for your product or service rather than assuming the category.
The registration threshold and the 30-day rules
The registration threshold is £90,000 of taxable turnover. De-registration is possible if turnover falls below £88,000. GOV.UK says you must register if either of these applies:
- Looking back: your total taxable turnover for the last 12 months went over £90,000. The 12 months are a rolling period, not a tax year or a calendar year, so you must check every month.
- Looking forward: you expect your taxable turnover to go over £90,000 in the next 30 days alone.
Under the backward test, you have 30 days from the end of the month in which you passed the threshold to register, and your registration takes effect from the first day of the second month after you passed it. If you pass the forward test, you register by the end of the 30-day period, and the effective date is when you realised it.
A worked example: a freelance designer invoices £7,000 a month, so her rolling 12-month turnover reaches £84,000. In month 13 she wins a large project and her turnover over the last 12 months goes from £84,000 to £91,000. She has passed the threshold at the end of that month, so she has 30 days from the end of the month to apply, and VAT would normally apply from the first day of the second month after the month in which she went over. If she misses that, she is liable for VAT from the date she should have been registered, and will have to pay it out of her own pocket if she did not charge customers VAT.
Which sales count? It is “taxable turnover”, which means standard-rated, reduced-rated and zero-rated sales, but not exempt or outside-the-scope sales. Remember that the figure is turnover, not profit: a business with £95,000 of sales and £60,000 of costs is over the threshold. Check the current threshold on GOV.UK each year, since it is set by the government.
Should you register voluntarily before the threshold?
You can register below the threshold if you wish. Whether it helps depends on your customers.
| Your customers | Effect of registering voluntarily |
|---|---|
| Mostly VAT-registered businesses | Usually helpful. They can reclaim the VAT you charge, so your price is no higher to them in real terms, and you can reclaim VAT on your costs. |
| Mostly consumers, or businesses that cannot reclaim VAT | Often unhelpful. Your price to them rises by 20%, or your margin shrinks if you absorb it. |
| You buy a lot of VAT-able equipment or stock | Possibly helpful, because you reclaim VAT on the purchases. |
| You make zero-rated sales | Possibly helpful, because you charge 0% but can reclaim VAT on costs. |
There are also non-tax effects. Being VAT-registered can look more established to some larger customers, but it adds record-keeping, deadlines and a digital filing requirement. Registering is not something to do casually, because you cannot easily go back without meeting the rules for deregistration.
What to charge: net, gross and the maths
Once registered, you need to be clear about whether a price is net (before VAT) or gross (including VAT). Here are the calculations using the House of Calculator VAT engine:
| Starting point | Calculation | Result |
|---|---|---|
| Net £150 | Add 20% VAT | £30 VAT, £180 gross |
| Gross £240 | Remove 20% VAT | £200 net, £40 VAT |
| Net £60, reduced rate | Add 5% VAT | £3 VAT, £63 gross |
| Net £7,500 | Add 20% VAT | £1,500 VAT, £9,000 gross |
To remove VAT from a gross price at 20%, divide by 1.2, not by taking 20% off. A £240 price is £240 ÷ 1.2 = £200, and VAT is £40. Taking 20% off £240 gives £192, which is wrong. This is the most frequent arithmetic mistake in small business pricing, and Percentage increase and decrease, and reverse percentages covers the reasoning behind it.
When you become VAT-registered, you have a choice about pricing. Either you keep your price the same and VAT comes out of it, which cuts your income by 1/6 (a £120 price becomes £100 net plus £20 VAT to HMRC), or you add VAT on top, which raises the price for your customers by 20%. Think about which is realistic for your market, and plan before you cross the threshold, not after. Do not forget that existing contracts may state prices without saying whether VAT is included.
Charging VAT on invoices
A VAT invoice has to show certain information, so check the current requirements on GOV.UK. In outline, it should show your VAT number, the date, a description of the goods or services, the net price, the rate and the amount of VAT. If your customers are VAT-registered businesses, a correct invoice is what lets them reclaim the VAT, so errors can cause problems for them.
Other practical points:
- You cannot charge VAT until you have a VAT number. After applying, the number arrives and the effective registration date is set, and VAT may be due from an earlier date, which you need to take into account.
- You must keep VAT records and, with limited exceptions, keep them digitally and use software to submit returns. The GOV.UK pages describe the digital record-keeping requirement as applying to most businesses.
- VAT returns are normally quarterly, with the payment due at the same time as the return, so a good rule is to set aside the VAT collected on each invoice as it arrives.
A worked VAT return
Imagine a small business with a quarter in which it sells £7,500 of standard-rated goods and buys £3,000 of standard-rated supplies and equipment, all net of VAT.
| Line | Net | VAT at 20% |
|---|---|---|
| Sales (output VAT) | £7,500 | £1,500 |
| Purchases (input VAT) | £3,000 | £600 |
| VAT to pay to HMRC | £900 |
The VAT due is output VAT minus input VAT, so £1,500 − £600 = £900. The gross receipts from customers were £9,000, of which £1,500 is VAT. The business pays HMRC £900, and its real income from the quarter is £7,500 less £3,000 of costs, which is £4,500, before other overheads and income tax. If the purchases had been larger than the sales, the return would show a refund due from HMRC.
Two cautions. Not all purchases carry reclaimable VAT: business entertainment, for example, generally does not, and cars have special rules. And you can only reclaim VAT on costs that relate to your business and are backed by a valid VAT invoice. Check the rules for any large or unusual purchase.
VAT schemes that can help a small business
HMRC offers several schemes designed to simplify VAT for smaller businesses. They suit different situations, and each has eligibility limits and conditions, so confirm the details on GOV.UK before applying.
- Flat Rate Scheme. You pay HMRC a fixed percentage of your turnover instead of working out output minus input VAT. GOV.UK says you can join if your VAT turnover is £150,000 or less excluding VAT. The catch is that you generally cannot reclaim VAT on purchases, apart from certain capital assets over £2,000. It can reduce paperwork, and sometimes a business keeps the difference between what it charges and what it pays, but it is not always cheaper, and it can cost more if you buy many VAT-able goods. The percentage depends on your trade sector.
- Annual Accounting Scheme. You make advance payments through the year and one annual return. GOV.UK gives the entry limit as an estimated VAT taxable turnover of £1.35 million or less. It can ease cash-flow planning but delays refunds if you normally reclaim VAT.
- Cash Accounting Scheme. You account for VAT when you are paid and when you pay suppliers, instead of when invoices are issued, which helps if customers pay late. Check the eligibility on GOV.UK.
If you are weighing a scheme, compare the cost under the standard method and the scheme on a realistic year of sales and purchases. An accountant can help with this, particularly for the Flat Rate Scheme, where the answer depends on how much VAT you pay on your own costs.
Common mistakes small businesses make with VAT
- Not monitoring the rolling 12 months. The threshold is not a tax-year figure. Check your total each month, and keep an eye on a one-off large job.
- Forgetting that turnover is not profit. The threshold looks at sales, so a low-margin business can pass it with little profit.
- Treating VAT as income. The VAT you collect belongs to HMRC less what you reclaim. Keep it separate.
- Removing VAT with the wrong sum. Divide by 1.2 for a gross price at 20%, not subtract 20%.
- Reclaiming VAT without an invoice. You generally need a valid VAT invoice for the purchase.
- Mixing up zero-rated and exempt. They have different effects on what you can reclaim.
- Missing the registration deadline. Late registration can leave you owing VAT you did not charge, and penalties may apply.
- Not planning the price change. Decide whether VAT will come out of your margin or go on top before you cross the threshold, so that existing customers are not surprised.
Try the calculator
Add VAT to a net price or remove it from a gross price with the VAT Calculator, and use it to check the VAT lines on your own invoices and returns.
Frequently asked questions
What is the VAT registration threshold?
It is £90,000 of taxable turnover over any rolling 12 months, according to GOV.UK, and you must also register if you expect to go over £90,000 in the next 30 days alone. Check GOV.UK for the current figure, because it can change.
Do I have to register for VAT if I am a sole trader?
The threshold applies to the business, whatever its legal form, so a sole trader with taxable turnover over £90,000 must register. If your turnover is below the threshold, registration is optional.
How do I take VAT out of a price?
At 20%, divide the gross price by 1.2. For £240 including VAT, the net price is £200 and the VAT is £40. Do not take 20% off the gross price, which gives the wrong answer.
Can I reclaim VAT on business purchases?
Generally yes, if you are VAT-registered and the cost is for business use and backed by a valid VAT invoice. There are exceptions, such as business entertainment and some car costs, and the Flat Rate Scheme usually does not allow reclaiming VAT on purchases.
What happens if I register late?
You may owe VAT from the date you should have registered, even if you did not charge customers, and HMRC can charge penalties. If you think you are late, contact HMRC promptly or ask an accountant.