How does VAT work?
Every VAT registered business charges VAT on what it sells (output tax) and reclaims the VAT it paid on what it bought (input tax). It pays HMRC the difference. The tax sticks only with whoever cannot reclaim it: the consumer at the end of the chain.
Businesses act as collectors, a bit at each stage of the supply chain.
What are output tax and input tax?
Output tax is the VAT you charge on your sales. Input tax is the VAT you pay on business purchases and expenses. Each VAT period you pay HMRC your output tax minus your input tax. If input tax is bigger, HMRC pays you the difference.
Output tax minus input tax = VAT you pay HMRC
Example: in one quarter you charge £5,000 VAT on your sales and pay £1,200 VAT on your costs. You pay HMRC £5,000 minus £1,200, which is £3,800.
A repayment is common for businesses that make mainly zero rated sales, or that have just bought expensive equipment.
Worked example: timber to table
Three VAT registered businesses and one customer. All figures at 20%.
A timber merchant sells wood to a furniture maker for £40 plus £8 VAT. The maker turns it into a table and sells it to a shop for £100 plus £20 VAT. The shop sells the table to a customer for £200 plus £40 VAT.
| Business | Sells for (ex VAT) | Output tax | Input tax | Pays HMRC |
|---|---|---|---|---|
| Timber merchant | £40 | £8 | £0 | £8 |
| Furniture maker | £100 | £20 | £8 | £12 |
| Shop | £200 | £40 | £20 | £20 |
| Total | £40 |
The customer pays £240 for the table. Of that, £40 is VAT. HMRC receives exactly £40, collected in three pieces: £8 + £12 + £20.
Each business pays VAT only on the value it added. The maker turned £40 of wood into a £100 table, adding £60 of value. It paid £12, which is 20% of £60. The shop added £100 and paid £20.
None of the businesses is out of pocket on VAT. Each collected more from its customer than it handed over, and passed the rest to HMRC. The customer cannot reclaim anything, so the £40 stays with them.
To add VAT to a price or take it out of one, use the VAT calculator or the reverse VAT calculator.
Who actually pays VAT?
The final consumer pays the tax. Businesses handle the money but do not bear the cost, as long as they are VAT registered and the VAT relates to taxable sales. VAT becomes a real cost for consumers, unregistered businesses and businesses making exempt sales.
Why each group is left holding it:
- consumers, who cannot reclaim it
- businesses that are not VAT registered, because they are under the threshold
- businesses that make exempt sales, such as insurers and most landlords of homes, who cannot reclaim VAT on related costs
A small business that is not VAT registered pays VAT on its costs and cannot charge it on its sales. That is why some register voluntarily. See the VAT registration threshold for when registration becomes compulsory.
What are the VAT rates?
Most goods and services carry VAT at the standard rate of 20%. Some are reduced rated at 5%, some are zero rated at 0% and some are exempt. Zero rated and exempt both mean the customer pays no VAT, but they work differently for the business.
- Standard 20%: most goods and services, adult clothes, restaurant meals.
- Reduced 5%: home energy, children's car seats.
- Zero 0%: most food, children's clothes, books.
- Exempt: insurance, financial services.
The UK VAT rates guide explains the difference between zero rated and exempt.
Do you have to register for VAT?
You must register when your taxable turnover goes over £90,000 in any rolling 12 months. Below that, registering is optional. Once registered, you must charge VAT on taxable sales, issue VAT invoices, keep digital records, and file returns and pay on time.
The VAT invoices you give business customers must show your VAT number and the VAT charged.
How does a VAT return work?
Most businesses file a VAT return every three months, though some file monthly or once a year. The return reports your sales, your purchases and the VAT on each. The deadline is usually 1 month and 7 days after the period ends, and payment is due the same day.
The VAT deadline calculator gives your exact date. Returns must be filed through Making Tax Digital compatible software. You cannot type them into the HMRC website any more. Read Making Tax Digital for VAT for what that means in practice.
The main boxes on the return, with what the shop in the example above would enter for its one sale:
| Box | What goes in it | Shop example |
|---|---|---|
| Box 1 | VAT due on your sales (output tax) | £40 |
| Box 4 | VAT reclaimed on your purchases (input tax) | £20 |
| Box 5 | The difference: what you pay, or what HMRC pays you | £20 |
| Box 6 | Total sales, excluding VAT | £200 |
| Box 7 | Total purchases, excluding VAT | £100 |
Boxes 2, 8 and 9 mostly matter to Northern Ireland businesses moving goods to and from the EU. Box 3 is the total of boxes 1 and 2.
Filing or paying late leads to penalty points, fines and interest. See VAT penalties for how they work.
What to do next
- Add VAT to a price with the VAT calculator, or take it out with the reverse VAT calculator.
- Check whether you need to register with the VAT threshold calculator.
- Once registered, find your return date with the VAT deadline calculator.
- Read HMRC's own overview of how VAT works on gov.uk.
This guide is general information. Check gov.uk or ask an accountant about your own case.
Questions
What is VAT in simple terms?
VAT is a tax on spending. Businesses add it to their prices, usually at 20%, and pass it to HMRC after taking off the VAT they paid on their own costs.
Who pays VAT, the business or the customer?
The customer. VAT registered businesses collect it and pay it over, but they reclaim the VAT on their own costs, so the final consumer bears the tax.
What is the difference between output tax and input tax?
Output tax is the VAT you charge on sales. Input tax is the VAT you pay on business costs. You pay HMRC output tax minus input tax.
Can HMRC pay me VAT back?
Yes. If your input tax is more than your output tax in a period, HMRC repays the difference.
How do I work out VAT on a price?
Multiply the net price by 20% to get the VAT. Or use the VAT calculator to add or remove VAT in one step.
Figures in this guide come from our rules file, last checked against HMRC on 4 October 2026.
