VAT is complex, but there are steps you can take to help
VAT is one of the most common sources of stress for business owners. Handled well, it becomes a routine part of running your business. Handled poorly, it can lead to penalties, HMRC enquiries, and unnecessary cash flow pressure.
VAT penalties are no longer based on a simple surcharge system. Since January 2023, HMRC operates a points-based penalty regime for late filing and late payment.
Each missed VAT return adds one penalty point to your account. Once you reach the threshold for your filing frequency (four points for quarterly filers), a £200 financial penalty is charged. Late payment penalties are separate: HMRC charges 3% on any tax unpaid at day 15, a further 3% at day 31, and 10% per annum for amounts outstanding beyond that.
The simplest way to avoid late payment is to set up a direct debit with HMRC. Your quarterly payment is then taken automatically from your business bank account.
There are four VAT rates in the UK: exempt, zero rated, 5% (reduced rate), and 20% (standard rate). You must apply the correct rate to every sale you make.
There are five categories that relate to VAT liability. A supply could be ‘Outside the Scope’ of VAT altogether, or it may be exempted by law so that no VAT can apply to it. It could then enter the range of VAT rates, and VAT could apply at 0%, 5% (reduced rate), or 20% (standard rate) depending on the nature of that activity or supply.
This is not always straightforward. Some services sit on the boundary between being positive-rated rated or exempt, or some goods sit between standard and reduced– or zero-rated. Getting this wrong can result in underpaid VAT, HMRC penalties, or difficulties reclaiming input VAT. If you are unsure which rate applies to your products or services, take advice early.
Once registered for VAT, your VAT number must appear on all invoices.
HMRC offers several VAT schemes, and the right one depends on the size and nature of your business.
You account for VAT on invoices issued and received, regardless of whether payment has been made.
You only account for VAT once you have been paid, which can benefit businesses with slow-paying customers, but you can only recover VAT on invoices that you have paid.
You apply a fixed percentage (depending on your trade class definition) to your gross turnover rather than calculating VAT on each transaction individually; this simplifies the process and can be financially beneficial if your input VAT costs are low as there is no recovery of VAT on costs incurred. In your first year on the scheme, your flat rate percentage is reduced by 1%.
You submit one VAT return per year instead of four and make 9, monthly, advance payments based on your previous year’s liability; useful for reducing admin.
If you run multiple entities, it may be possible to register them as a single VAT group, which can simplify accounting and remove VAT on intragroup transactions. HMRC updated its VAT grouping rules in late 2025 following changes in case law.
The current VAT registration threshold is £90,000. If your turnover has dropped below £88,000, you may be eligible to deregister.
HMRC requires all VAT-registered businesses to keep digital records and submit VAT returns using Making Tax Digital (MTD) compatible software. This has applied to all VAT-registered businesses since April 2022.
Your digital records must include details of all sales and purchases, VAT amounts charged and reclaimed, and any adjustments made to your returns. Paper records alone are no longer sufficient for VAT purposes.
Accurate records also protect you if HMRC opens a VAT enquiry. Being able to produce clear, organised documentation will help resolve any investigation quickly and reduce the risk of additional penalties.
If your business trades internationally, VAT treatment on cross-border transactions can be complex. Postponed VAT accounting allows UK businesses importing goods to account for import VAT on their VAT return rather than paying it at the point of entry, which helps cash flow. A £135 customs threshold currently applies to most imported goods, below which different rules on VAT apply.
Post-Brexit rules continue to evolve, so it is worth reviewing your import and export VAT position regularly.
HMRC has confirmed that e-invoicing will become mandatory for VAT purposes, with a rollout roadmap expected to be set out at Budget 2026. Businesses will be required to issue and receive VAT invoices in a specified electronic format, affecting how you store records and interact with your accounting software. Now is a good time to make sure your systems are up to date.
VAT is an area where small errors can have significant consequences. Our team can help you choose the right VAT scheme, ensure your records meet HMRC requirements, and represent you if you are subject to a VAT enquiry.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information on this page is intended as a general guide only. While we work to keep our content accurate and up to date, we cannot guarantee that it reflects the position at the time you are reading it. No responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm. For more information on our editorial process, click here.
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