How does VAT work?

VAT is a tax on consumer spending.  Under the system, every VAT registered business is effectively a tax collector.

Most transactions are standard rated (currently at 17.5% in the UK at the time of writing).  However, transactions could also be zero-rated, exempt or outside the scope of VAT.

A VAT registered business has to pay (to HMRC) the amount of output tax (that is the VAT it charges on it’s sales) less the input tax (the VAT that it pays on it’s purchases).  Sometimes, this figure is negative (for example, if the business is engaged in making zero-rated supplies – that is, the goods/services that the business sells are zero-rated for VAT purposes), in which case, the business can reclaim the VAT from HMRC.

Each vat registered business charges VAT (normally at 17.5%) on it’s VATable supplies and so on, down the chain, until eventually the consumer (or non-vat-registered business) bears the final cost of the VAT.

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