Value Added Tax is a tax on spending.The more you spend on goods and services with VAT, the more VAT you will pay. Standard VAT registered businesses are generally unaffected by VAT in terms of their costs but act as VAT collectors. The unregistered business or you, the private person will ultimately pay the VAT. For this reason, VAT is an indirect tax: it’s not collected from you by the government; instead, it’s collected by the businesses in the supply chain.
Company A makes a widget and sells it to Company B for £100+VAT(at 20%) = £120.
Company A‘s output VAT (the VAT on it’s sale) is £20.00 which it pays to HMRC
Company B‘s input VAT (the VAT on it’s purchase) is also £20.00 and can be reclaimed, giving a cost of only £100
Company B does a bit of additional work and sells the super widget to Company C for £150+VAT = £180.
Company B‘s output VAT (the VAT on it’s sale) is £30.00 which it pays to HMRC
Company C‘s input VAT (the VAT on it’s purchase is also £30.00 and can be reclaimed, giving a cost of only £150
Company C does a bit more work and sells the resulting super-duper widget to Person D for £200+VAT = £240
Company C‘s output VAT (the VAT on it’s sale) is £40 which it pays to HMRC.
Let’s suppose that Person D, is a private individual, who is therefore not registered for VAT.
D therefore cannot reclaim the £40 of VAT that it’s paid.
So the total cost to D is £240.
D ends up paying the entire cost of the eventual VAT charge.Quick explanation of how #VAT works. Click To Tweet
If a business is making zero-rated supplies, (ie, the products or services it sells), it charges VAT at zero percent, as opposed to charging no VAT. The distinction, although pedantic, is important: These businesses can reclaim all the VAT on the purchases.
If a business is making exempt supplies, it cannot charge VAT on it’s sales and it cannot reclaim the input VAT on it’s purchases.
If a business makes only some exempt supplies, it would only be able to claim the VAT on purchases related to it’s VATable supplies. (The Partial Exemption area of VAT is a whole area of VAT rules, in itself – which is lots of fun if you like ratios and percentages.)