Published: 28 Mar 2023
Last updated: 23 May 2023
As a small business owner, it is important to understand what Value Added Tax (VAT) exemption is and when it applies. VAT exemption is a tax incentive that allows businesses to avoid charging customers the standard VAT rate on goods and services. In some cases, businesses are even allowed to reclaim the tax they have already paid. This guide will help you gain a better understanding of who is eligible for VAT exemption, as well as how to claim it.
What is VAT?
Value Added Tax (VAT) is a type of indirect tax which businesses must pay to the government on goods and services supplied. It applies to every stage of the supply chain from manufacture all the way to the consumer. VAT works by adding a percentage of the item's price onto the cost for each stage in the process, giving rise to its name. By collecting taxes at many stages along the production chain, it reduces evasion due to under-the-table dealings and is relatively difficult to skirt around or avoid. The funds collected as VAT goes on to be used by governments for various public expenses like infrastructure improvements, healthcare, education etc. This can potentially have an impact on citizens' quality of life.
What is VAT exemption and how does it work?
VAT exemption is an important, though often complicated and misunderstood, concept. In essence, it allows certain items or services to be exempt from value-added tax (VAT). This is beneficial for both consumers and businesses as it can reduce costs, increase demand and make taxes more straightforward. To qualify for VAT exemption, goods must fall under one of the recognised categories, which are largely related to social necessities such as health services, fresh food and educational services. As long as the criteria are met and properly documented, the government will issue an exemption certificate that confirms the goods or services in question are indeed exempt from VAT.
Exempt or out-of-scope goods and services
There’s a wide range of activities, services, and items that are entirely exempt from VAT, including:
- Education and training from eligible schools, colleges, or universities
- Charity donations and events
- Health services
- Insurance, financial services, and investment
- Royal Mail postal service
- Sports, leisure, and cultural activities
Certain items, deemed too important to impose taxes on, are zero-rated, making them accessible and affordable for buyers. These include:
- Most food, including non-alcoholic drinks, such as bread, vegetables, fruits and cereals
- Children’s clothing and footwear (including material for making kids' clothes)
- Books, newspapers and magazines (including digital versions)
- Pharmaceutical products used to treat humans or animals, such as medicines and first aid supplies
- Passenger transport services by bus, train or boat that originate in the UK
- Domestic fuel and power
Due to the exempt nature of these products, it is often seen by many businesses as a way for them to remain competitive with other suppliers who may be selling similar goods and services that are subject to the standard rate of 20% VAT.
Knowing the correct way to accurately submit your VAT Return is essential for businesses that sell goods with zero- or reduced-rate items. GOV.UK issued VAT Notice 700/12, which outlines precisely how this should be done. Check Section “3.7. Filling in box 6” to understand how to show the total value of your sales while excluding reduced rate items.
Reduced rate items
Some items are set at a reduced rate of 5% including:
- Mobility aids such as wheelchairs or scooters
- Installations helping to achieve energy savings
- Admission fees to certain cultural events
- Sports activities for children under 17 years old
- Repairs to listed buildings and national monuments
- Children’s car seats
Discounts and gifts
If you are looking to reward customers with discounts or free gifts, then understanding the VAT regulations is essential! Depending on what type of promotion you're offering – either a discounted item or complimentary gift alongside an order - there will be different rules as to whether standard taxation applies.
For full information on the rules, GOV.UK has all the information and know-how needed to make sure your business stays compliant on its 'Discounts & Free Gifts' page.
How does VAT exemption affect businesses?
Value Added Tax (VAT) exemption can have a major impact on businesses in the UK, depending on their size and the goods or services that they sell. Below, we will explore some of the key considerations for VAT exemption across different types of businesses.
VAT Exempt Businesses
Businesses which are considered “zero-rated” are exempt from paying VAT on the goods and services that they sell. They do not need to register for VAT nor charge any tax on sales. Examples of zero-rated items include food, books and pharmaceuticals.
Partially Exempt Businesses
Partially exempt businesses are those who have an annual turnover below £85,000 and do not need to register for VAT. Such businesses will only pay tax on a limited number of sales and can reclaim any VAT paid on related costs within the business.
Charity organisations are usually fully exempt from paying VAT on the majority of their activities, including donations made by non-business owners and those related to healthcare services. Charities may also be eligible to reclaim any tax paid as part of their fundraising efforts.
Business Selling Zero-Rated Items
Businesses in this category must still register with HM Revenue & Customs (HMRC), but they don't have to charge customers any taxes while selling zero-rated items like food, books or pharmaceuticals. However, these businesses will still have to account for all sales using invoices or other forms of documentation so that HMRC is aware of revenue generated through such activities.
Frequently Asked Questions
Is Insurance VAT exempt?
In most cases yes; insurance companies are typically subject to standard rate taxation when it comes to premiums charged for general policies such as car or house insurance but some exemptions can apply in certain circumstances - it is best to check with your provider or HMRC before moving forward with any transactions regarding insurance services.
Do you pay VAT on business rates?
Generally speaking no; business rates are generally non-taxable unless the property is rented out commercially in which case the landlord may be required to account for applicable taxes.
Is Postage VAT exempt?
Yes; postage is typically zero rated regardless whether sold in shops or online meaning no taxes apply when sending letters or parcels.
What is the difference between zero-rated and exempt?
Zero-rated items refer to those which incur no tax charges when purchased whereas exempt items offer reduced taxable rates than would normally apply should you purchase them from other retailers.
Do you pay VAT on congestion charges?
Currently there is no Value Added Tax applied when purchasing London’s Congestion Charge however this could change in future.
Can I apply for Value Added Tax Exemption?
Yes; depending upon your company’s size and local taxation guidelines you may be eligible for exemptions - contact your local taxes authority office for more information.
This does not constitute advice if you want to understand your business tax liability in detail you should speak to your accountant.