Value Added Tax
A consumption tax charged at each stage of production and distribution on goods and services, with the final burden falling on the end consumer. VAT-registered businesses collect VAT from customers (output tax) and reclaim VAT paid on their own purchases (input tax), remitting only the net difference to HMRC. The main rates are standard (20%), reduced (5%), and zero (0%).
How it works
VAT is collected in stages throughout the supply chain rather than only at the final sale — each VAT-registered business charges VAT on what it sells (output tax) and can reclaim the VAT it paid on its own business purchases (input tax). Only the net difference is actually paid over to HMRC, which means the tax effectively falls on the end consumer even though it's collected incrementally at every stage.
Which rate applies depends on the specific goods or service being sold, not the business selling it — the same VAT-registered shop might sell some items at the standard 20% rate, others at the reduced 5% rate, and others at 0%, all within a single VAT return. Correctly classifying each supply matters because getting it wrong can mean under- or over-charging customers and misreporting the return.
Only VAT-registered businesses charge and reclaim VAT — a business below the VAT registration threshold that hasn't registered voluntarily simply doesn't charge VAT at all, and also can't reclaim any VAT it pays on its own purchases, which is an important trade-off to weigh when deciding whether to register early.
Example: output tax, input tax, and the amount owed to HMRC
A VAT-registered business buys stock for £100 plus £20 VAT (its input tax) and later sells that stock for £200 plus £40 VAT (its output tax). It has collected £40 from the customer but paid out £20 to its supplier.
On its VAT return, the business pays HMRC the difference: £40 output tax − £20 input tax = £20. The customer effectively bears the full £40 VAT, but the business only hands over the value it added itself.
Frequently asked questions
Do all businesses have to charge VAT?
No — only businesses that are VAT-registered charge and account for VAT; a business below the VAT registration threshold that hasn't registered voluntarily doesn't add VAT to its prices at all.
Can a VAT-registered business reclaim VAT on everything it buys?
Generally yes for business purchases used to make taxable supplies, but certain categories like business entertainment and some cars have specific restrictions, so not every purchase automatically qualifies for a full reclaim.
Why do some goods have no VAT charged at all?
Certain essential goods and services are zero-rated or exempt for policy reasons — zero-rated supplies like most food are still technically taxable, just at 0%, while exempt supplies sit outside the VAT system entirely, and the distinction affects whether a business can reclaim related input VAT.
Related Terms
Standard Rate VAT
The main VAT rate of 20% applied to most goods and services sold in the UK by VAT-registered businesses.
Reduced Rate VAT
A 5% VAT rate applied to certain goods and services deemed essential or beneficial, including domestic fuel and power, children's car seats, and some energy-saving materials.
Zero Rate VAT
A 0% VAT rate applied to certain essential goods and services, including most food, children's clothing, books, and prescribed medicines.
VAT Registration Threshold
The level of taxable turnover above which businesses must register for VAT, currently £90,000 per rolling 12-month period.
VAT Return
A periodic report that VAT-registered businesses must submit to HMRC, typically quarterly, showing the VAT they have charged customers and the VAT they have paid on purchases.
Flat Rate Scheme
A simplified VAT accounting method for small businesses with an annual turnover below £150,000, where you pay a fixed percentage of your gross turnover to HMRC instead of accounting for input and output VAT separately.
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