The Difference Between Zero VAT and VAT Exemption

When charging VAT, the rate charged depends on what the goods or services are. Most items are subject to the standard rate of VAT, but there are other categories:

  • standard rate VAT is currently set at 20%, and applies to most goods and services if VAT is charged
  • reduced rate VAT, which is set at 5%. Utilities, such as electric and gas, are subject to this rate of VAT.
  • zero-rated 0% VAT applies to most foods, and to children’s clothing
  • Some items are also VAT exempt.

It’s these final two in the list that often cause the most confusion, because they seem like they might do the same job. They are actually separate, and are treated in different ways. We’ll focus on them in this article to help businesses avoid the VAT trap.

Zero Rated VAT versus VAT exempt

The easiest way to explain how 0% rated VAT is different from VAT exemption is to compare the two.

What is 0% zero rated VAT? What is VAT exemption?
Goods and services categorised as 0% or zero-rated VAT are still taxable goods, but the rate of VAT charged is 0%. VAT exempt goods and services are not taxable, and no VAT can be charged on them.
Goods and services that fall into the zero-rated VAT category include:

  • Advertising services for charities
  • Charity shops selling donated goods
  • Building services for disabled people
  • Equipment for disabled people
  • Water supplied to households
  • Sale or long lease of a new dwelling with a garage or parking space
  • Brochure printing
  • Magazines and newspapers
  • Children’s clothes and footwear
Goods and services that fall into the exempt VAT category include:

  • Lottery ticket sales
  • Betting and gambling
  • Antiques
  • Sponsored charity events
  • Burial or cremation
  • Education services
  • Parking
  • Some financial services

 

So what’s the difference?

A business which sells zero rated VAT goods and services can benefit from being VAT registered. This is because of how it deals with input and output tax:

  • the VAT that a business pays on goods and services it buys is known as input tax
  • When a VAT registered business charges VAT on its taxable sales, this is known as output tax. The business essentially collects VAT from its customers, and then passes the tax on to HMRC when it pays its VAT bill.

This has an important effect on the business’s VAT return:

  • If a VAT registered business pays more VAT on the products and services it buys than it collects on sales, the business can reclaim the difference between what it has paid, and what it has collected.
  • When a VAT registered business collects more VAT on its sales than it pays on the products and services it buys, then the business must pay the difference to HMRC when they pay their VAT bill.

What might it mean for the business?

The crucial thing here is that zero rated items don’t actually incur a charge, because the VAT is 0%. If a business sells only (or mostly) 0% rated items, the VAT it pays on things it buys will probably be more than the VAT it collects from customers.

This means that the business can claim the difference back from HMRC.

Showing it on your VAT return

If a business dealing with both zero-rated and VAT-exempt goods or services, then some of its sales are partly exempt. The business must be careful to categorise invoices correctly to avoid errors on the VAT return.

Whether 0% rate or exempt from VAT, both will need to be recorded in the VAT return.

Pandle automatically calculates VAT returns every time it issues an invoice, or logs a transaction. This makes VAT returns straight-forward and much easier to manage. Find out more about how Pandle supports VAT-registered businesses.


Elizabeth Hughes

A content writer specialising in business, finance, software, and beyond. I'm a wordsmith with a penchant for puns and making complex subjects accessible.