VAT in the UK: Understanding Zero Rating, Reduced Rating, and Exemption
Value Added Tax (VAT) is a tax on consumer expenditure, collected on business transactions, imports, and acquisitions. In the UK, VAT is governed mainly by the Value Added Tax Act 1994, as amended by subsequent Finance Acts. This article will delve into the specifics of zero rating, reduced rating, and exemption in the context of VAT in the UK.
Understanding VAT Rates
VAT rates in the UK have varied over time. The zero rate has existed since VAT was introduced into the UK on 1 April 1973. The standard and reduced rates have seen changes, with the current standard rate being 20% since 4 January 2011, and the reduced rate being 5% since 1 September 1997.
In the UK, the VAT (Value Added Tax) system includes three types of treatments for different types of goods and services: zero-rated, reduced-rated, and exempt. Here's a brief explanation of each:
Zero-rated VAT: Goods and services that are zero-rated are still VAT-taxable, but the rate of VAT is 0%. This means that while no VAT is charged to the customer, the supplier can still reclaim any VAT they have paid on business expenses related to these goods or services. Examples include most food and children's clothes.
Reduced-rated VAT: Some goods and services are charged VAT at a reduced rate of 5% in the UK. The reduced rate applies to certain specific goods and services, such as home energy or children's car seats.
Exempt: Some goods and services are exempt from VAT. If a good or service is exempt, no VAT is charged to the customer and the supplier cannot reclaim VAT on their expenses related to these goods or services. Examples include financial services and health services provided by doctors.
It's important to note that the classification of goods and services into these categories is determined by the UK government and is subject to change. For example, the government may choose to move goods or services from one category to another in response to policy goals or economic conditions.
Let’s diver into 3 main types of lower VAT rates:
Some supplies of goods and services are charged at a reduced rate. These reduced-rated supplies are taxable and include the right of the person making the supply to recover the VAT on their own business expenditure, subject to certain restrictions.
Example of Reduced-rated Supplies
Here are the examples of the reduced rating VAT supplies in the UK
Cable-suspended passenger transport systems: The 5% reduced rate of VAT applies to cable-suspended passenger transport systems that carry under 10 passengers, such as ski lifts.
Caravans and houseboats: Under certain conditions, the sale of a caravan may be reduced-rated.
Charities: Fuel and power supplied to charities for their non-business use are reduced-rated.
Children’s car seats: The reduced rate applies for children’s car seats.
Construction work: Work to convert buildings for residential or charitable use may be reduced-rated.
Contraceptive products: Depending on the circumstances, contraceptive products may be reduced-rated.
Energy-saving materials: The installation of specified energy-saving materials can be reduced-rated.
Fuel and power: Some supplies of solid fuels, oils, gases, electricity, heating, refrigeration, and air-conditioning are liable at a reduced rate.
Grant-funded installation of heating equipment or security goods: The reduced rate applies to the installation of certain heating appliances, central heating, renewable source systems, and security goods in the sole or main residence of qualifying persons, where the work is grant-funded.
Hotel, hostel, and similar accommodation: Supplies of accommodation for an individual guest who stays for over 28 consecutive days may be able to apply the ‘reduced value rule’.
Mobility aids for the elderly: The supply and installation of certain mobility aids for customers aged 60 or over can be eligible for the reduced rate of VAT.
Smoking cessation products: The supply of smoking cessation products can be reduced-rated.
Welfare advise or information: The reduced rate can apply to advice or information that relates directly to the physical or mental welfare of elderly, sick, distressed, or disabled people, or the care or protection of children and young people, as long as it is of a general nature.
Women’s sanitary protection products: Certain sanitary products can be supplied at a reduced rate.
VAT is not payable on zero-rated supplies, and an invoice for a zero-rated supply will not constitute a VAT invoice. However, zero-rated supplies are treated as taxable supplies in all other respects, including the right of the person making the supply to recover the VAT on their own business expenditure, subject to certain restrictions.
Thus, Zero-rated goods and services are those that are taxable but at a rate of 0%. This means that the customer does not have to pay any VAT as it is charged at a rate of 0%, but because the supply is taxable the supplier can reclaim VAT paid on the costs of making that supply. Examples of zero-rated goods and services include most food items and children's clothing.
Example of Zero-rated Supplies
Here are some examples of zero-rated VAT:
Bank notes: The first issue, by the bank of issue, of Bank of England, Scottish, and Northern Irish bank notes is zero-rated (VAT Notice 701/49).
Books, newspapers, periodicals: Certain supplies of books, newspapers, periodicals, leaflets, music, maps, and other printed matter are zero-rated (VAT Notice 701/10).
Caravans and houseboats: Certain circumstances allow the supply of a caravan or houseboat to be zero-rated (VAT Notice 701/20).
Charities: Some supplies made by or to charities are zero-rated, including advertising supplied to charities and goods donated to a charity for sale (VAT Notice 701/58, 701/1).
Children’s clothing and footwear: Certain supplies of young children’s clothing and footwear can be zero-rated (VAT Notice 714).
Construction: Work to construct a dwelling, residential or charitable building can be zero-rated, as can the sale or long lease of dwellings, certain residential buildings, and certain buildings used by charities (VAT Notice 708).
Disabled reliefs: Goods specifically designed for disabled persons or services specifically aimed at assisting a disabled person may be zero-rated when supplied to a disabled person for personal use (VAT Notice 701/7).
Drugs, medicines: The dispensing of drugs, medicines, and other items to patients by a pharmacist or doctor is zero-rated in certain circumstances (VAT Notice 701/57).
Exports: Certain goods and services related to export procedures can be zero-rated (VAT Notice 703, 703/1, 703/2, 704, 707).
Food, catering, and agriculture: Certain supplies of food and drink for human consumption are zero-rated (VAT Notice 701/14).
Gold: Certain supplies of gold are zero-rated (VAT Notice 701/21).
Health: Some supplies by health professions and institutions are zero-rated (VAT Notice 701/31, 701/57, 701/7).
Imports: The supply of imported goods between their arrival in the UK and delivery of the import entry can be zero-rated (VAT Notice 702).
Intermediary services: Zero rating applies to certain intermediary services (VAT Notice 741A).
Land and buildings: The sale or long lease of certain types of dwellings, residential buildings, and buildings used by charities can be zero-rated (VAT Notice 708, 742).
Passenger transport, international freight, ships, and aircraft: Certain supplies of freight and passenger transport, and supplies in the ship and aircraft construction and repair industry can be zero-rated (VAT Notice 744A, 744B, 744C).
Protective equipment: The zero rating applies to motorcycles, cycle, and other protective helmets and protective boots (VAT Notice 701/23).
Tools for the manufacture of goods for export: Supplies of certain tools to overseas customers, where the tools are used in the UK solely for the manufacture of goods for export, are zero-rated (VAT Notice 701/22).
Training services supplied to overseas governments: Training services supplied to overseas governments can be zero-rated (VAT Notice 741A).
Water and sewerage services: Certain supplies of water and sewerage services are zero
Some supplies are exempt from VAT, which means that no tax is payable. Equally, the person making the supply cannot normally recover any of the VAT on their own expenses. However, it’s possible to choose to standard rate some supplies of property which would otherwise be exempt, by opting to tax, whereby the supplies you make of an interest in land or buildings, or both, will, in most cases, become taxable. Thus, Certain goods and services are exempt from VAT. This means that they are not subject to VAT, and therefore do not incur the standard 20% VAT charge.
Example of Exempt Supplies
Here's a list of supplies that are exempt from Value Added Tax (VAT) in the UK as of 2023:
Physical education and sports activities
Betting and gaming — including pool betting and games of chance
Bingo — including remote games played on the internet, telephone, television or radio
Lottery ticket sales
Online lottery games
Retailer commission on lottery ticket sales
Admission charges by public authorities or eligible cultural bodies to certain cultural events such as visits to museums, art exhibitions, zoos and performances
Antiques, works of art, or similar (as assets of historic houses) sold by private treaty to public collections
Antiques, works of art or similar (as assets of historic houses) used to settle a tax or estate duty debt with HMRC
Admission charges by charities
Charitable fundraising events
Voluntary donations to charity
Burial or cremation of dead people, or burial at sea
Funeral plans written under contracts of insurance
Care or medical treatment provided by a qualifying institution like a hospital, hospice or nursing home
Health services provided by registered doctors, dentists, opticians, pharmacists and other health professionals
Education, vocational training and other connected services provided by an eligible body like a school, college or university
Garages or parking spaces let together with dwellings (under shorthold tenancy agreements) for permanent residential use
Parking — grant, or license, to occupy land on which incidental parking takes place
Property, land and buildings — grant, or license, to occupy land or buildings
Parking spaces or garages supplied with houseboat moorings
Financial services including the issue, transfer or receipt of, or dealing with money, securities for money, or orders for the payment of money
The granting of credit such as loans
The management of credit by the person who has granted it
The provision of the facility ofinstalment credit finance for example hire-purchase
The provision of qualifying financial intermediary services
The issue, transfer or dealing with security, including shares and bonds
The operation of a current, deposit or savings account
The management of a qualifying special investment fund
Financial service is supplied as a separate element but with other goods or services
Financial service supplied as part of a single supply with other goods or services, if financial service is the principal element of the supply
Gold investment coins
Friendly society subscriptions for the provision of insurance1.
In addition, some supplies are charged at a 0% VAT rate, which is technically different from being exempt but in practice also means no VAT is charged. Such goods and services include, for example, babywear, children’s clothes and footwear, and certain types of printing and publications like books and newspapers.
Please note that this list is not exhaustive and some exceptions may apply. For the most accurate and up-to-date information, it is best to check the official UK government website or consult a tax advisor.
Differences Between Zero-Rated VAT and VAT-Exempt
There are five main differences between Zero-Rated VAT and VAT-Exempt in the UK:
Taxable Status: Zero-rated goods or services are considered taxable, but at a rate of 0%, meaning VAT is not added to the selling price, but the items are still considered within the scope of VAT12. On the other hand, exempt goods or services are not considered taxable at all, which means they fall outside the scope of VAT.
Reclaiming VAT: If a business sells or supplies zero-rated goods or services, it can reclaim the VAT on any purchases that relate to those sales. However, if a business only sells or supplies goods or services that are exempt from VAT, it cannot recover any VAT incurred on its purchases or expenses.
Recording and Reporting: Both zero-rated and exempt items must be recorded in the business's records. However, only sales of zero-rated goods or services need to be reported on the business's VAT return. Sales of exempt goods or services are not included in the business's taxable turnover for VAT purposes.
Registration for VAT: Businesses selling exempt goods or services cannot register for VAT, whereas businesses selling zero-rated goods or services can register for VAT and are required to do so if their taxable turnover exceeds £85,00021.
Types of Goods and Services: The types of goods and services that fall into each category are also different. Zero-rated goods and services can include things like books, newspapers, most food, and certain types of medical equipment. Exempt goods and services, on the other hand, can include financial or property transactions, insurance, finance and credit, education and training, and fundraising events by charities.
Why the Distinction Matters
As a buyer, it makes very little difference whether a product or service is exempt or zero-rated – no VAT is payable either way. But as a seller, it makes a difference to whether VAT incurred on the costs of providing the goods or services can be reclaimed from HMRC. And if most of a business’s costs have VAT on them, it can make a massive difference.
Can Goods or Services be Both Zero-Rated and Exempt from VAT?
Generally speaking, when no VAT is charged on a supply of goods or services it is because the supply is either zero-rated or exempt. However, sometimes it is not so clear cut. For example, the transport of patients falls under the broader exemption of VAT for healthcare services – applying this exemption meant the client could not claim back the VAT on their costs. However, a company that provided such services argued successfully at a VAT Tribunal that they were also making a supply of passenger transport services, which was zero-rated and they were, therefore, entitled to claim back the VAT on associated costs such as vehicle purchasing and maintenance.
Determining Whether Your Sales are Exempt from VAT or Zero-Rated
Whether goods or services are exempt from VAT or zero-rated depends on the specific nature of the supply and the laws of the country where they are being sold. Many things that are considered necessities are either exempt or zero-rated and therefore not subject to VAT. To determine whether your sales are exempt from VAT or zero-rated, you could start by consulting the HMRC guidance or, better still, seek the advice of a qualified VAT specialist.
Understanding the different VAT rates and their applications is crucial for businesses in the UK. By ensuring compliance with VAT rules and regulations, businesses can avoid unnecessary penalties and interest charges. If you're unsure about any aspect of VAT, it's advisable to seek professional advice or contact the VAT general inquiries helpline. Remember, while this guide provides an overview of VAT rates in the UK, it's not exhaustive. For more detailed information, you should refer to the official government guidance or consult a tax professional.