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The Difference between Zero-Rated VAT, VAT Exempt & Out of Scope of VAT

There is sometimes confusion over what the difference between Zero-Rate VAT, VAT Exempt & Out of Scope VAT. Zero-Rate VAT items, such as books, childrens clothes and some food, do have VAT on them, it’s just at zero percent, so the actual VAT is nil. (In Sage, the VAT code to use would be T0). However, the net purchase cost of zero-rate items still goes in Box 7 of a VAT Return. Suppliers of zero-rated goods/services can still reclaim all their input VAT (the VAT on their own purchases) VAT Exempt items, such as postage stamps, do not have VAT on them (not even at 0%). The VAT is nil. (In Sage, the VAT code to use would be T2). However, the net purchase cost of VAT Exempt items still goes in Box 7 of a VAT Return. Suppliers of Exempt goods cannot reclaim the input VAT (the VAT on their own purchases) relating to Exempt Supplies. Out of Scope items would be those purchases made from unregistered businesses and private individuals. (In Sage, the VAT Code would be T9). These purchases do not appear at all in the VAT Return (Clearly, there was no VAT charged, but also, as they are completely outside the VAT system, the cost should not appear in Box 7 of the VAT Return either) Out of Scope & VAT Codes in Sage There is some confusion, even in accounting circles (as demonstrated on Accounting Web), regarding how to deal with Out of Scope items. Some suggest that the T0 or T1 Sage code be used for these transactions (and manually overriding the automatically calculated VAT figure, in the case of the T1 code). This is incorrect. Even though the goods/services might ordinarily be VATable, until the supplier is VAT Registered, it’s out of scope. A side effect of erroneously including these transactions in the VAT Return, is that Box 7 would be artificially high. This may not be significant amount, but be warned that HMRC do carry out statistical checks to ensure that Box 1 & 6 and Box 4 and 7 do correlate to each other.

Completing a Standard VAT Return on Sage

Following the previous post, for those using Sage, the process is greatly automated, provided that you have used the correct Sage VAT Codes, of course.

  • Go into Financials and select the VAT Return option.
  • Enter the correct start and end dates for the VAT Quarter in question.
  • Click the “Calculate” button (at this point, provided you have marked the previous quarter’s VAT transactions as reconciled, you can opt to choose “Yes” to include unreconciled transactions, if that option appears)
  • Print both the VAT Return and the Detailed report (either in hard copy or to pdf)
  • As an additional check, you could also print the Nominal Activity Report for the same date range, and check that it agrees to the figures on the VAT return report.
  • Once happy, take a backup of the Sage data.
  • Mark the VAT Transactions as reconciled by clicking the “Reconcile” button.  This ensures that the transactions won’t be included on a future VAT return by accident.
  • Run the VAT Transfer Wizard (from the Modules menu).  The VAT Liability nominal code is usually 2202.  Date the transfer journal as at the last day of the VAT quarter that is being completed.  This clears the Sales & Purchase VAT codes to zero (assuming that there were no errors) and makes future errors easier to find.  It also credits the VAT Liability Code, 2202 with the amount of VAT to be paid to HMRC.
  • Submit the Return by paper, online or alternatively (depending on your version of Sage) using Sage’s online submission.
  • When the VAT is actually paid to HMRC, process this a bank payment using the same VAT Liability Nominal Code (usually 2202) as above.  Sage will automatically debit this nominal code bringing it down to zero.

How to fill in a VAT Return – Standard Quarterly Accounting

This scenario is for VAT registered businesses, who use the standard accounting method for VAT and complete their returns quarterly.

Simply add up all the sales for the VAT quarter, before VAT.  This is your net sales figure and it goes in Box 6 on the VAT return.

Add up all the VAT on those sales.  This is your output VAT and goes into Box 1 on the VAT return.

Similarly, add up all the purchases

Add up all the VAT on the purchases.  This is your input VAT and goes into Box 4 on the VAT return.

For Box 7 of the VAT return: Add up all the net purchases (excluding VAT), make sure to include any purchases that had VAT at zero percent or that were VAT exempt.
EXCLUDE purchases from unregistered suppliers, as these are out of scope and not to be included on a VAT return.

The Symmetry of VAT

I’ve blogged before about how VAT works, so here, I’m just going to highlight the symmetry of the VAT chain in the UK by considering a hypothetical supply chain of VAT-registered businesses, Company, A, B, C.

Company A makes a widget and sells it to Company B for £100+VAT = £117.50
Company A’s output VAT (the VAT on it’s sale) is £17.50 which it pays to HMRC
Company B’s input VAT (the VAT on it’s purchase) is also £17.50 and can be reclaimed, giving a cost of only £100
Company B does a bit of additional work and sells the super widget to Company C for £150+VAT = £176.25
Company B’s output VAT (the VAT on it’s sale) is £26.25 which it pays to HMRC
Company C’s input VAT (the VAT on it’s purchase is also £26.25   and can be reclaimed, giving a cost of only £150
Company C does a bit more work and sells the resulting super-duper widget to D for ££200+VAT = £235
Company C’s output VAT (the VAT on it’s sale) is £35 which it pays to HMRC.

Let’s suppose that D, is a private individual, who is therefore not registered for VAT.
D therefore cannot reclaim the £35 of VAT that it’s paid.
So the total cost to D is £235.

D bears the entire cost of the eventual VAT charge.

If a business is making zero-rated supplies, (ie, the products or services it sells), it charges VAT at zero percent, as opposed to charging no VAT.  The distinction, although pedantic, is important: These businesses can reclaim all the VAT on the purchases.
(Some examples of zero-rated goods are given here)

If a business is making exempt supplies, it cannot charge VAT on it’s sales and it cannot reclaim the input VAT on it’s purchases.
If a business makes only some exempt supplies, it would only be able to claim the VAT on purchases related to it’s VATable supplies.  (The Partial Exemption area of VAT is a whole huge area of VAT rules, in itself, which I will address in a later post)

A business that is unregistered for VAT or a private individual, is completely outside the VAT system.  Obviously, they cannot charge or reclaim any VAT at all.
HMRC deems these businesses and individuals to be “out of scope“.

Mothballs

Good grief, it’s been a while!

I am currently overhauling the company website  and blog, but they will probably be divergent for a few more weeks, (these things always take longer than anticipated) as obviously client work has to take first priority.  I do hope to get back on track (erm, but I know that I’ve said that before). 

In the meantime, I’ve finally joined Twitter, which you should also be able to see from the feed on the right.  So, I’ve had a bit of fun setting that up (no, really, I have).  I wish I’d done it sooner!  Many of the bloggers that I’ve blogrolled, are now also on Twitter, and I’ll probably post more about this at a later date.

A couple of blogs seem to have been deleted altogether and one or two have moved or changed direction.   It looks like I’ll have to update my blogroll…

Changes in Corporation Tax

As part of the Budget, it has been announced that the Corporation Tax rates will change from 1 April 2011:

Main rate of Corporation Tax will fall to 27% (from 28%)

Small Companies Rate of Corporation Tax will fall to 20% (from 21%)