Value Added Tax (VAT)

Value Added Tax or VAT is a UK sales tax which is charged on the sale of most goods and services. It is a charge to the end consumer and is not something an organisation gets to keep. Instead they must keep track of how much is collected and pay this to HMRC.

VAT is calculated as a percentage and is currently 20% but this is subject to change, for years it was 17.5% and for a brief time it was reduced to 15%.

In order to reclaim (or pay) VAT business must register themselves as a VAT registered business with HMRC (this can be voluntary but is compulsory once turnover exceeds a certain threshold). Once registered business must keep their financial documents such as invoices and credit notes for a minimum of six years.

HMRC inspects business who are VAT registered to make sure they are paying the right amount of VAT.

Calculating VAT From a VAT Inclusive Price

Calculating VAT when it's not been included is fairly straight forward by following usual percentage calculations. Sometimes however (particularly in a primarily customer focused business) VAT rates are included in the price of an item sold. In this case the VAT need's to be calculated from a price which includes VAT.

The simplest way to calculate VAT and the goods value from a VAT inclusive price is to first find out 1% of the total value and then multiply this by 100 to get the goods value and by the VAT percentage amount to get the VAT value.

One way is to calculate this is to multiply by the percentage you want to find out.

To use a simple example to calculate VAT on a price which doesn't include VAT the goods total is 100%, the VAT percentage is 20% so the total amount due is 120% - this is the equivalent percentage (100% good total + 20% VAT). If we were to put figures in say £200 (100%) is the goods total - the VAT due would be £40 (20%) so the total would be £200 (100%) + £40 (20%) = £240 (120%).

We can then use this to demonstrate going the other way - to find the goods total divide the total paid (£240) by the equivalent percentage (120%) i.e. the percentage of goods total + VAT percentage and multiply this by 100 to give a goods total of £200 or:

£240 / 120 x 100 = £200

And to find the VAT paid divide the total paid (£240) by the equivalent percentage (120%) and multiply the total amount by the VAT rate (20%):

£240 / 120 * 20 = £40

VAT is collected by business on behalf of HMRC

VAT is a tax for end consumers, not business so a VAT registered business is essentially a tax collectors for HMRC, they charge VAT to their customers on sales they make and record any VAT they have paid.

They then pay HMRC the difference or in some cases they can receive a refund (say if they paid out more VAT than they received.)

This is why VAT is a liability, once it has been collected the business is liable to pay it to HMRC.