What is the Difference Between Zero VAT and VAT Exemption?

By Elizabeth Hughes

10 July 2024

VAT

4 mins

Table of contents

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?

0% or zero-rated VAT goods and services are still taxable, but the rate of VAT charged is 0%.

Goods and services which are zero-rated for VAT include:

Advertising services for charities
Charity shops selling donated goods
Building services for disabled people
Equipment for disabled people
Water supplied to households
Brochure printing
Magazines and newspapers
Children’s clothes and footwear

What is VAT exemption?

Goods and services exempt from VAT are not taxable, so no VAT can be charged on them.

Examples of VAT-exempt goods and services include:

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

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.

This is a key point because of the effect it can have on tax efficiency.

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.

Learn more about using Pandle to make business accounting easier. Create an account today and decide what to do with all the extra time you get back.

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.