The rate of VAT that must be charged varies depending on what goods or services are being supplied. Most items are subject to the standard rate of VAT but there are other categories, including those which are zero rated or even exempt from VAT altogether. In this article we go over what it means to be zero rated versus VAT exempt, and the impact this has on your business.
What are the different rates of VAT?
- Standard rate VAT: Set at 20%, this rate applies to most goods and services which are subject to VAT
- Reduced rate VAT: Currently charged at 5% on things like utilities (such as electric and gas)
- Zero-rated 0% VAT: Applies to most foods, as well as to children’s clothing
- VAT exempt: Items which are not subject to a VAT charge at any rate
It’s the final two on the list that often cause the most confusion, because zero-rating something seems like it might do the same job as making it VAT exempt. They are actually separate, and are treated in different ways. Which we’ll explain next.
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? |
| 0% or zero-rated VAT goods and services are still taxable, but the rate of VAT charged is 0%. | Goods and services exempt from VAT are not taxable, so no VAT can be charged on them. |
Goods and services which are zero-rated for VAT include:
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Examples of VAT-exempt goods and services include:
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Why does it matter?
So why is it important to identify zero-rated items separately to VAT exempt ones? Well, a business which sells zero-rated goods and services can register for VAT. A business which deals exclusively in supplying things which are VAT-exempt cannot.
When a business charges VAT on taxable sales (you’ll sometimes see this called output tax) it is essentially collecting VAT from its customers, and then passing it along to HMRC when it pays its VAT bill.
- If the business pays more VAT on the products and services it buys than it collects on the sales it makes in the same period of time, it can reclaim the difference between what it paid and what it 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
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 purchases will probably be more than the VAT it collects from customers.
This means you can claim the difference back from HMRC on a regular basis, which is great news for tax efficiency! It’s why some businesses decide to register for VAT voluntarily, even though their turnover hasn’t reached the registration threshold.
A business which only supplies VAT-exempt items can’t take advantage of this though, because it can’t register for VAT.
Recording VAT exempt and zero-rated sales correctly
Businesses should record all of their transactions anyway, because this helps you stay on top of your finances, make well-informed decisions, and submit accurate tax returns.
If your business deals with both zero-rated and VAT-exempt goods or services, then some of your sales are ‘partly exempt’ so it’s even more important to categorise everything correctly! When you make your VAT submission, it will show both your zero-rated sales as well as those which are exempt.
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very well explained and easy for us in the office to finally understand. THANK YOU for clarifying the above. Makes a complete sense 🙂