Demystifying VAT: How it Affects Your Small Business

7 Jul 2023

As the owner of a small business in the United Kingdom, one of the essential financial aspects you will likely encounter is Value Added Tax (VAT). Often considered a complex area of UK tax legislation, a solid understanding of VAT can provide crucial insights that could affect your business operations, profitability, and compliance with HM Revenue & Customs (HMRC) regulations.

What is VAT?

VAT is a consumption tax levied on most goods and services sold in the UK, charged at various rates depending on the nature of the item in question. Essentially, it represents the ‘value added’ at each stage of production or distribution of goods and services. 

The standard rate for VAT is 20%, with a reduced rate of 5% for certain goods and services, and a zero rate for others. Check the latest rates and categories on the HMRC website to stay updated.

Who Needs to Register for VAT?

If your business’s VAT taxable turnover (the total value of everything you sell that isn’t exempt from VAT) exceeds the current threshold of £85,000, you are required to register for VAT with the HMRC. It’s also possible to voluntarily register even if your turnover is below this threshold, which can sometimes yield financial benefits. 

To check the current threshold or to register for VAT, you can visit the HMRC website.

The Impact of VAT on Your Business

Let’s illustrate VAT’s impact with a simple example:


Imagine you run a software development company, creating bespoke software solutions. Your company sells a software package to a client for £10,000. As software services are standard-rated, you must add 20% VAT to this price, making the total cost to the client £12,000. This additional £2,000 is then paid to HMRC.

However, during the production of this software, you purchased a new laptop for £1,200, including £200 VAT. As a VAT-registered business, you can reclaim the £200 VAT you paid, reducing the total VAT you need to pay to HMRC from your software sale to £1,800. 

This process of adding VAT to the sale price of your goods or services, and deducting VAT you’ve paid on business-related goods or services, is the fundamental principle of VAT accounting.

VAT and Brexit

With the UK’s departure from the EU, VAT rules for trade between the UK and EU countries have changed. It is crucial to stay informed about these changes to ensure your business remains compliant. For more information, visit the HMRC Brexit transition guide.

While the world of VAT can seem overwhelming, understanding these fundamental aspects can aid your business planning and decision-making processes. By ensuring VAT compliance, you can avoid unnecessary penalties and even identify potential opportunities for savings.