VAT (Value Added Tax) CALCULATION: The Full Guide

VAT (Value Added Tax) CALCULATION: The Full Guide

Everyone pays VAT (Value Added Tax) when they buy goods or services in the UK. It is also crucial for businesses who are VAT registered to understand how VAT works and how to calculate VAT. This guide will break down the calculations in a simple easy to understand format.

CONTENT

WHAT IS VAT?
HOW DOES VAT WORK?
PENALTIES FOR LATE PAYMENT
UK VALUE ADDED TAX RATES
WHY DO GOVERNMENTS CHARGE VAT
HOW TO ADD VAT (VALUE ADDED TAX) TO A PRICE?
HOW TO DEDUCT VAT (VALUE ADDED TAX) TO A PRICE?
ANOTHER WAY TO LOOK AT THIS VAT EXAMPLE
A GLOSSARY OF VAT TERMS FOR BUSINESSES
VAT CALCULATOR: ADDING VAT
VAT CALCULATOR: DEDUCT VAT

WHAT IS VAT?

Value added tax or VAT is one of the several taxes that we pay to HMRC. Unlike direct tax – such as income tax or National Insurance, which is paid directly to HMRC, VAT is collected from the end consumers by the companies which sell the goods and services, which is why it is also called an indirect tax.

Glossary: Indirect Tax

It is a tax based on goods and services provided, as opposed to income incurred. This category also includes excise duties and other taxes such as air passenger duty.

HOW DOES VAT WORK?

Companies and self-employed individuals can be involved in the buying, selling and re-selling of the same item such as in the case of a retailer buying goods from a manufacturer and then selling it onwards in their shop.

Ultimately, VAT is a tax on the final consumer, meaning that a company is required to pay the VAT, however, they must account for it on behalf of HMRC, as it is easier to collect VAT from end consumers through company VAT returns rather than collecting the VAT from each individual consumer.

Glossary: VAT return

A form submitted to HMRC monthly or quarterly which shows the value of the goods and services provided along with the total purchases for the period which includes direct cost and admin expenses. These figures are used to calculate the net VAT position for the company and they may be in a net payable position or in a net refund position.

Better said, even though companies are responsible for accurate VAT filings and sometimes receive VAT refunds or make VAT payments, the consumer is the one who ultimately pays the tax and for the companies, it is just an accounting exercise.

The company acts as an intermediary to collect the tax from the masses on behalf of HMRC. Therefore, they are legally required to appropriately account for VAT and keep formal records which are true and complete as the amounts represent taxes collected on behalf of HMRC.

However, companies and self employed individuals with a total turnover under £85,000 need not register for VAT as the volume of the sales is not high enough to warrant this complex accounting exercise.

Companies may voluntarily register for VAT in this case, but they should be aware of their responsibilities in this case and the potential fines.

Glossary: VAT threshold

If a company has total sales exceeding £85,000 in a one year period they must register for VAT. This level of turnover is called the VAT threshold.

PENALTIES FOR LATE PAYMENT

There is a multitude of VAT penalties, with the most common being penalties for late filings.

Overall, they can run very steep and may even be crippling to a business found on the wrong side of the law.

This can be avoided by using an experienced advisor who specialises in the intricacies of UK VAT.

UK VALUE ADDED TAX RATES

VAT is based on the value of the goods and services provided, taking into account the VAT category they fall under. The UK sets their own VAT threshold levels, however, as part of the European Union, the standard threshold must be at least 15%. The thresholds for VAT in UK are as follows:

  • Standard rate: 20% – the majority of goods and services, unless they fall in the other categories below
  • Reduced rate: 5% – domestic heating fuel, children’s car seats, over the counter smoking replacement or cessation products, energy saving materials used in construction and renovation works on an empty residential building
  • Zero rate: 0% – books, newspapers, children’s clothes etc.

WHY DO GOVERNMENTS CHARGE VAT

Governments usually use taxes to encourage certain economic behaviour which leads to positive changes within society.

While this is not always perfectly done in practice, VAT laws are aimed at encouraging certain types of consumer spending through reduced or even zero-rated taxes. However, this balance can be tricky to accomplish and can leave some baffled.

For example, the VAT on the sale of helicopters is 0%, but female disposable tampons are considered a non-essential luxury product and the VAT on them is 5%!

Find out more on why Government’s charge VAT

NB: Difference between Zero Rate and Exempt from VAT

Zero rated goods and services are still under the scope of VAT, therefore HMRC will need information on the level of sales in your VAT filings. Goods and services which are exempt from VAT do not need to be included in your VAT return. Simply put, there is no VAT in both cases, however for Zero Rated goods and service appropriate accounting and record keeping must still be kept for VAT filings.

HOW TO ADD VAT (VALUE ADDED TAX) TO A PRICE?

Let us see a practical example of how to add VAT and how it works?

Manufacturer: Sybil
Retailer: Basil
End consumer: Manuel
Product: Rat poison

Sybil produces Rat poison and sells it for £10 per pack as her desired income. Her client is Basil, an in keeper who also has a small shop selling necessary goods in his inn. On top of the usual selling price, Basil must also pay the VAT associated with the sale, in this case 20% on the base price. Therefore, Basil will pay £12 for the rat poison.

Glossary: Base price

In this case, the selling price net of VAT (£10) is the base price on which the VAT percentage (20%/5%/0%) is applied.

ADDING VAT CALCULATION FORMULA
VAT is at a rate of 20%
Net price multiplied by 1.2 = Gross price Price before tax multiplied by 1.2 = Price after tax

Use a VAT Calculator to Add VAT

Base price X VAT % = £10 X 20% = £2

This can be calculated easier with a calculator as 1+VAT %, ie. 1+0.20 = 1.2 and then multiply it by the base price. It’s a much simpler method and the result is the same..

Total VAT = 10 X 1.2 = £12

HOW TO DEDUCT VAT (VALUE ADDED TAX) TO A PRICE?

If Sybil were to charge a total of £10 for the rat poison, how can we extract the VAT amount from the total prices?

DEDUCTING VAT CALCULATION FORMULA
VAT is at a rate of 20%
Gross price divided by 1.2 = Net price Price after tax divided by 1.2 = Price before tax

Use a VAT Calculator to Deduct VAT

This is the calculation you need to use when:
you know a price after tax (the Gross price)
but want to find out the price before tax (the Net price).

£10 (Total price inclusive of VAT) = X (base price) X 1.2

X = £10 / 1.2 = £8.33

VAT = £10 – £8.33 = £1.67

Let’s return to the previous example…

Sybil sells rat poison to Basil for £12. Basil sells this in his shop for £20 and Manuel needs to purchase it.

£20 (total price) = Y (base price) X 1.2

Y = £20 / 1.2 = £16.67

VAT = £20 – £16.67 = £3.33

Company/IndividualVAT inVAT out= VAT position
Sybil – Manufacturer£20£2*
Basil – Retailer£3.33£2£1.33*
Manuel – End consumer0£3.33£3.33**

 * Sybil and Basil are both companies which must pay VAT collected to HMRC.

** Manuel is the end consumer, therefore he is the one that ultimately pays the VAT which was collected through Sybil and Basil. It would be too difficult for HMRC to collect this tax from each individual who makes purchases, therefore it relies on proper accounting by the commercial entities involved in the transactions.

If Sybil or Basil were to make a mistake on their VAT filing, HMRC would collect the wrong amount than what Manuel has actually paid.

ANOTHER WAY TO LOOK AT THIS VAT EXAMPLE

Company/IndividualNet Selling price exclusive of VATVAT chargedTotal price inclusive of VATP&L
Sybil£10£2£12+£10
Basil£16.67£3.33£20+£6.67

We do not know how much Sybil bought the rat poison for, so we will assume that her net selling price is also her profit.

Basil spends £12 and charges Manuel £20. He also pays £1.33 to HMRC as his Net VAT position. If Basil would have sold the rat poison for less than £10, at a loss to his business, he would claw back the difference from HMRC through a VAT refund.

Company/IndividualNet Selling price exclusive of VATVAT chargedTotal price inclusive of VATP&L
Sybil£10£2£12+£10
Basil£8£1.6£9.6-£2

In the case that Basil was forced to sell the rat poison at a loss of £2,  he would, at least, claw back £0.40 from HMRC as he paid VAT of £2 to Sybil but the end consumer only paid £1.6 on his purchase.

Glossary: VAT refund

Most of the time, companies are in a net VAT liability position, meaning that they sold goods and services and charges VAT on them and now they must pay back this VAT to HMRC. However, certain companies or in certain periods a company can be in a net VAT refund position. This can happen in a time when a company’s sales are down, purchases and expenses are up or, in the case that the company mostly sells zero rated supplies but buys goods and services which are at a standard (20%) or reduced (5%) rate.

A good tax adviser can help you figure out how much VAT you owe, or if, by contrast, you are eligible for a VAT refund. Especially for companies which are registering for VAT for the first time, you may be eligible to go back up to 4 years for purchases made before registration.

If you liked this article, please see the other articles we have on Small business accounting, VAT, Income tax, and more.


A GLOSSARY OF VAT TERMS FOR BUSINESSES

VAT is something that the majority of businesses could most likely do without, given the choice.

After all, high rates both at home and abroad have the potential to eat into a business’ profitability and then there are the complex legal issues to consider around areas such as VAT registration and compliance.

With that in mind, Brighton-based Accordance VAT has put together this helpful glossary of terms associated with the world of VAT, so you’ll know your Intrastat from your input tax in no time.

13th DirectiveA procedure by which tax paying businesses established outside of the EU yet trading within the market can obtain a VAT refund.
Accounting PeriodThe time covered by any VAT return (see below).
AcquisitionsThe process by which an importer receives goods from a supplier in an EU member state that is exempt from VAT (Andorra, Channel Islands, Gibraltar, Mount Athos, San Marino and Vatican City).
Commodity CodesA unique code applied to a product(s) so that it can be identified in international commerce. It is eight digits in length for exports leaving the EU and ten digits for imports coming from outside of the EU. It allows businesses to look up duty rates and any restrictions that may be in place.
Distance SellingRefers to the movement of a product(s) between a VAT-registered business to a customer who is not registered for the tax. In other words, this will mainly apply to online transactions between a business and a private individual.
ExportsSimply, products or goods sent from within the EU to a country or state outside of it.
ERP (Enterprise Resource Planning) CodingA process of integrating information across an entire organisation, at the same time as facilitating the flow of it to external parties. It is therefore essential for calculating inter-state VAT and reporting requirements.
Input TaxThe amount of VAT paid on purchases.
IntrastatIntrastat reporting is required by companies trading across EU borders so that each member state’s tax authority can monitor the movement of goods around the EU and chase up any unpaid VAT incurred in that particular state. It also allows statistics on cross-border trade to be compiled for research and informational purposes.
Place of SupplyThe place in which the supply of goods must be registered for VAT purposes.
Nature of Transaction CodeOtherwise abbreviated to NoTC, this is a record of the type of transaction declared as part of Intrastat reporting. Types of transactions include sales or acquisitions, free-of-charge goods or services.
Refund DirectivePut in place to ensure that EU taxable enterprises can gain access to a ‘VAT rebate’ from transactions occurring in member states in which they are not registered, the refund directive takes into account the company in question’s inability to submit VAT returns in that particular country.
Self-BillingThis refers to when a customer issues a VAT invoice themselves, a copy of which they include along with their payment to the supplier
VATValue added tax, paid by the consumer of a good or service. Rates vary across different countries.
VAT RegistrationAn important element for businesses, registering for VAT enables them to charge and recover local VAT on an international basis. Some regions only require a business’ registration once their annual turnover exceeds a certain amount.
VAT ReturnsA requirement of businesses registered for value added tax, these are reports that include details of all sales and services which are subject to it.
Tax PointThe date by which VAT has to be accounted for, usually when the goods/services been received/performed.

VAT CALCULATOR: ADD VAT

Use the VAT calculator below to add the VAT amount to the price you enter.

VAT CALCULATOR: DEDUCT VAT

Use the VAT calculator below to deduct the VAT amount from the price you enter.

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