What Is VAT? A Plain-English Explanation
VAT — Value Added Tax — is a tax on spending, not on income or profit. It's charged on most goods and services sold in the UK, added at each stage a product moves through a supply chain, from raw material to finished sale. Despite sitting on almost every receipt, it's one of the least understood taxes, mostly because the business charging it never actually keeps it. For how it got here, see our post on the history of VAT in the UK.
How VAT actually flows
A VAT-registered business charges VAT on what it sells — this is output tax. It also pays VAT on what it buys for the business — this is input tax. Each VAT period, usually quarterly, the business pays HMRC the difference between the two. If output tax is higher, it pays the balance to HMRC. If input tax is higher, HMRC refunds the difference.
In practice, this means a VAT-registered business is really just collecting the tax on HMRC's behalf. The VAT it charges customers was never its money to keep — that's why VAT sits in liability codes like 2200, 2201 and 2202 rather than in income or expense accounts.
Who has to charge it
A business must register for VAT once its taxable turnover passes £90,000 in any rolling 12-month period. Below that, registration is voluntary — some smaller businesses register anyway so they can reclaim VAT on their own purchases, particularly if most of their customers are VAT-registered businesses themselves and the added price doesn't put off consumers.
The three UK rates
Most goods and services are standard-rated at 20%. A reduced rate of 5% applies to a shorter list of items, including domestic energy and children's car seats. A zero rate of 0% covers most food, children's clothes, and books — these are still technically VAT-taxable, just at nil, which matters because it lets a business reclaim input VAT on costs behind zero-rated sales, unlike genuinely exempt supplies. HMRC publishes the definitive category-by-category list of VAT rates if you need to check where a specific product or service falls.
A worked example
Say a shop sells a £100 (net) item at the standard rate. It adds £20 of VAT, so the customer pays £120. That £20 is output tax — it isn't the shop's revenue, it's money held for HMRC. If the shop had paid £6 of VAT on stock and packaging to make that sale, that £6 is input tax it can reclaim, leaving £14 actually due to HMRC for that transaction.
Our VAT calculator does this arithmetic both ways — add VAT to a net figure, or pull VAT back out of a gross one — in case you'd rather check a number than do the maths by hand.
Why this matters day to day
Understanding VAT as money passing through, rather than money earned, changes how you read a set of accounts. A business with strong VAT-inclusive sales figures isn't necessarily doing well — the underlying net revenue is what matters for profit. And a VAT bill landing in the bank isn't a business expense; it's simply the point where money already collected from customers gets handed on to HMRC.