What is a Value Added Tax (VAT) and its main principle in a business formation of United Kingdom


The value added tax or VAT is defined as the tax that is liable to turnover and not on profits. The charge of tax is applicable on the value added, as it is evident from its name. This blog will familiarize its readers with the value added tax, its main principles, charge and scope of VAT and the registration for VAT by companies setting up a business UK.

To understand the concept, consider the example of a person who is in the chain of distribution or manufacture and makes the purchase of goods worth £1000 and then sales them for £1200, which means that £200 is the extra value or the added value of the goods. He might have acquired this increment of value by painting them, packing or making their distribution to various shops in order to provide justification of the mark-up, or it can also be the case that he/she is simply a master of purchasing goods at a cheap rate and then selling at a higher rate. Since the value that he has added is £200, then the VAT that he collects, with an assumed standard rate of 20%, is equal to £200 * 20% that equals £40. This payment is then paid to the Government. The collection of VAT is done along the chain in the form of bits. As a final step, the consumer is hit by VAT who did not consider adding value while making use of the goods.

It is interesting to note here that the value added tax is the kind of tax that is easy to compute but it involves some rules in detail to make sure that the VAT is enforced.

Main Principles

At every stage in the process of production, the charge of value added tax is applied on turnover. However, this is accomplished in such a manner that the final consumer bears its burden.

The value added tax Act 1994 (VATA 1994) provides the VAT’s legal basis with additional regulations that are defined by the statutory instrument and the amendment is made by the subsequent acts of finance. The administration of VAT is done by the HM Revenue and Customs (HMRC). The traders who are registered may subtract the tax that they suffer upon supplies to them (input tax), from the tax that they charge their customers for (output tax) at the time the payment is made to the HMRC. Hence, at every stage of the service or the process of manufacturing, the total VAT paid is applicable to the value added at that point or stage.

Since the traders are held accountable to HMRC for the charged value added tax minus the suffered VAT, their profits for the purposes of corporation tax or income tax are dependent on the net purchases and sales of VAT.

Scope of Value Added Tax

The charge of VAT is made on supplies of services and goods that are made by a person liable to tax when register a business in UK.

Basic Principles of VAT

As mentioned earlier, the charge of VAT is made on the supplication of services and goods that are made by a person or people who is/are liable to tax in the course of furtherance when they register a business in UK and carry it on. It is charged when the goods are imported in the UK by a person who makes the payment of tax. This is irrespective of the fact that the import is done for the purposes of business or not, and if the person who imports is a person liable to tax or not, and if in the case of some specific services acquired from abroad, if a person liable to tax acquires them for the purposes of business.

A taxable supply is defined as the supply of services or goods that are made in the United Kingdom by companies setting up a business UK, except the supplies that are exempt under certain conditions. The standard rate for a taxable supply is usually 20% since the taxable supply is either zero rated or standard rated.

The charge of some specific supplies such as the domestic fuel’s supply that comes under the category of supplies of standard rate, is at a reduced rate of 5%.

Supplying the Goods

If the exclusive ownership of the goods is passed to another person, then the supplying of goods occurs.

The examples of supply of goods are as under:

  • The assignment, grant or surrender of a main interest in land that is the freehold or a lease for 21 years and above.
  • The transfers that take place according to an agreement that contemplates the ownership’s transfer, for example, agreement of a hire purchase.
  • Supplying any kind of power, refrigeration, water, heat or ventilation.
  • When you take out goods from the business on a permanent basis in order to use them for the non-business type of purposes by a person who is liable to tax or for any other personal or private aims that includes the employer’s supply of goods to an employee for the use, private in nature

VAT is due in the case of gifts of goods and are normally under treatment as sales at cost. However, there exist cases in which the business gifts are not considered as the supplies of goods. These include the case when gift is a sample (number of samples allowed are unlimited) and the case if the net price of the gifts that are made to the same person is not more than £50 in any period of 12 months. If the limit of an amount of £50 is exceeded, the output tax in its full form is due on the net gifts made. Once the exceeding of limit occurs, then it commences a new period of 12 months and a new £50 limit.

Supplying the Services

A type of supply that is not considered as the supply of goods and done for the purpose of consideration is known as the supply of services. However, a few exceptions exist. What is consideration? It is any kind of payment in money or some other method, that includes something that itself is a supply. A supply of services is also said to take place in the case if the hiring and lending of goods to someone occurs who has to use it for the purposes not included in the business, and the case in which the services that are purchased for the purposes of business are used for the purposes that are personal or private in nature.

According to the European court of justice, the rule is that the restaurants provides or supplies services, and not goods.

Persons Liable to Tax

The persons who are liable to tax include partnerships considered as single entities and not individuals, clubs, companies, charities and associations. If a person is registering a new business UK, or is already in the business, and makes supplies liable to tax, then the taxable turnover is defined as the cost or value of these supplies. If the taxable turnover of a person after registering a new business UK becomes more than specific defined limits, then he is considered as a person who is taxable and must be registered for the value added tax (VAT).

Types of Registrations

If the values of the supplies that are taxable in a period up to 12 months is more than an amount of £79000 or if there are some grounds reasonable in nature for believing that the cost or value of the supplies liable to tax will be more than £79000 in the next 30 days, then a trader is said to be liable for the registration of VAT. However, a trader may also voluntarily register himself or herself for the value added tax.

The types of registration include the mandatory registration and registering voluntarily. Further types are group registration and divisional registration out of which, compulsory registration is described below.

Mandatory Registration

It is required for every trader to make a calculation of his/her cumulative turnover of supplies liable to tax till that date, at the end of each month. It is important to note here that the cumulative period must not extend more than the preceding 12 months. When the value of the cumulative supplies of tax increase from an amount of £79000, then the trader is said to be liable for the registration of VAT, as discussed earlier. The month in which the amount of £79000 limit exceeds, then the person is supposed to send a notification to the HMRC within 30 days since that month ended. As an answer to this notification, the HMRC registers the specific person from the ending of the month following the month in which the amount of £79000 got crossed, or from an earlier date if the trader come to an agreement.

There is no need for a registration under this rule in the case if the HMRC are satisfied with the fact that the cost of the taxable supplies of the trader (that does not include VAT), in the year when commencing, will not be more than an amount of £77000.

At any time, a person is also liable to register if there are required grounds for confirming that his supplies are liable to tax (that do not include VAT), in the next 30 days will be more than an amount of £79000. The only taxable turnover that is not considered as a cumulative turnover is the one that of 30-day period. A notification must be given to the HMRC by the termination of the 30 days’ period and hence the registration becomes applicable from the commencement of that period.

While making the determination of the cost of a person’s supplies liable to tax in order to fulfill the purposes of registration, supplies of services and goods that are the business’s capital assets should be disregarded, except for the taxable supplies that are non-zero, of interests in land.

In the case of a business making supplies liable to tax in the UK, but is not established there, then it has to go through the procedure of registering itself for VAT, irrespective of its value of the taxable supplies, that is, even if the value is under the threshold of registration of VAT.

When a person becomes liable for registration in relation to a preceding period, then that particular person is responsible for the payment of VAT. If the person is not able to collect the VAT from those to whom he performed the taxable supplies, then the burden of VAT will be on him. It is important for a person to begin saving the records of VAT and the amount of VAT charged from customers as soon as he gets to know that now is the time for VAT registration. However, the presenting of VAT should not be done separately on any of the invoices until the number of registration is known. The invoice must be showing the inclusive price with VAT and the buyers must be well informed that the invoices of VAT will be forwarded as soon as the number of registration is known. Then, the formal invoices for VAT must be sent to the customers within 30 days of the acquiring of the number of registration.

If a supply is made by a trader before he/she becomes liable to register, but he/she gets the payment after registering, then that supply is not liable to VAT.

There exists a VAT1 form on which the notification of liability to register should be made. The form can be downloaded from the website of HMRC, or an application for the registration can also be made through the website online. It is not sufficient to simply telephone or write to a local office of VAT.

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