Learning Outcomes
By the end of this article, you will understand how Value Added Tax (VAT) applies to businesses. You will be able to explain what constitutes a taxable supply, distinguish between input and output tax, know when a person must register for VAT, and recognise the main practical consequences of VAT for businesses and legal practice. This knowledge is essential for dealing with business taxation on the SQE2 exam.
SQE2 Syllabus
For SQE2, you are required to understand VAT as it applies to common business scenarios. Focus in your revision on:
- the meaning and scope of VAT in business, including what counts as a taxable supply
- distinguishing between input tax and output tax
- knowing when VAT registration is compulsory and the consequences
- completing VAT invoices, returns, and understanding payment and record-keeping obligations
- applying VAT rules to realistic legal and business situations likely to appear in SQE2 practical assessments
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is a taxable supply for the purposes of VAT, and when must a business register for VAT?
- Briefly describe the difference between input tax and output tax for VAT.
- Does a sole trader making only exempt supplies need to register for VAT?
- What general documents must VAT-registered businesses provide to customers and HMRC?
Introduction
VAT is a widely applicable tax in business law and practice. For SQE2, you must advise clients on when VAT applies, their responsibilities, and the results of failing to comply. This section explains the scope of VAT for businesses, focusing on the most examinable features.
The Scope of VAT
VAT is a tax levied on supplies of goods and services in the UK. The general rule is that VAT applies to taxable supplies made by taxable persons in the course or furtherance of a business.
Key Term: Value Added Tax (VAT)
A tax on the value added to most goods and services supplied by VAT-registered businesses in the UK.Key Term: Taxable supply
A supply of goods or services, other than those that are exempt, made in the UK by a taxable person during business activities, on which VAT is chargeable.Key Term: Taxable person
Any individual, partnership, company, or other organisation that is, or is required to be, registered for VAT because of making or intending to make taxable supplies above the registration threshold.
Types of Supplies
Most supplies are standard-rated (the normal rate is 20%), but some are zero-rated or reduced-rated (5%). Other supplies are exempt (such as education, medical services, certain land transactions, and insurance). VAT does not apply to exempt or non-business supplies.
VAT Registration
You must register for VAT if your taxable turnover in the previous 12 months exceeds the statutory threshold (currently £85,000), or if there are reasonable grounds to expect it will do so in the next 30 days. Registration is with HMRC. Voluntary registration is permitted for businesses below the threshold, but only those making taxable (not exempt) supplies.
VAT Invoices, Returns, and Record Keeping
A VAT-registered business must issue VAT invoices showing the VAT number and the VAT charged on each supply. Returns must be submitted, typically quarterly, to HMRC. Records must be complete and accurate for at least six years.
Key Term: Input tax
VAT paid by a business on goods and services purchased for use in its business, which it may be able to recover from HMRC.Key Term: Output tax
VAT charged by a business on goods and services it supplies to customers.
The VAT Calculation
The basic formula is: VAT payable to HMRC = output tax (collected from customers) minus input tax (paid to suppliers). Where input tax exceeds output tax, the business can claim a repayment from HMRC.
Worked Example 1.1
Sarah operates a small graphic design business. Her VAT-taxable turnover for the previous 12 months is £90,000. She buys stationery for £600 plus £120 VAT and invoices a client £1,000 plus £200 VAT. Under her VAT obligations, what does Sarah owe to HMRC for this transaction?
Answer:
Sarah is required to be VAT-registered as her taxable turnover exceeds the threshold. For this transaction, she collects £200 output tax from the client and pays £120 input tax on supplies. The VAT payable to HMRC is output tax (£200) minus input tax (£120), resulting in £80 due.
Worked Example 1.2
James is a sole trader making only private medical supplies, which are VAT-exempt. His turnover is £120,000. Does he need to register for VAT or issue VAT invoices?
Answer:
No, because all his income is from exempt supplies. He is not required (or permitted) to register for VAT and cannot issue VAT invoices.
Practical Consequences and Compliance
VAT is self-assessed; businesses must accurately account for VAT. Penalties can arise for late registration, incorrect returns, or late payments. Record keeping is essential, both for returns and for surviving possible HMRC inspection.
Exam Warning
Failure to register for VAT when required, or issuing VAT invoices without being registered, is a common exam scenario. Penalties range from surcharges to criminal prosecution. Always check if a business exceeds, or is likely to exceed, the threshold.
Revision Tip
For SQE2, memorise the current registration threshold and the main types of exempt and zero-rated supplies. Practice scenarios that require distinguishing input tax from output tax.
Key Point Checklist
This article has covered the following key knowledge points:
- The definition and purpose of VAT, taxable supplies, and taxable persons
- Registration for VAT: compulsory, voluntary, and exemptions
- Differences between input tax and output tax in VAT accounting
- VAT invoices, returns, and record-keeping duties for registered businesses
- Consequences of late, incomplete, or false VAT filings
- Examinable distinctions between zero-rated, exempt, and non-business supplies for VAT
Key Terms and Concepts
- Value Added Tax (VAT)
- Taxable supply
- Taxable person
- Input tax
- Output tax