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What Is VAT? Our Guide to Value-Added Tax in 2026.

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If you run a small business in the UK, it’s essential to understand Value-Added Tax (VAT). VAT is basically a tax on the value added to goods and services at each stage of production or distribution. It’s ultimately paid by consumers, but businesses are responsible for collecting it and sending it to the government. 

In this small business VAT guide, we explain Value-Added Tax in plain terms, including how it works, the current VAT rates, and practical tips to stay on top of your VAT obligations in 2026.

What is VAT and how does it work?

VAT (Value-Added Tax) is an indirect tax charged on most goods and services in the UK. ‘Indirect’ means the tax isn’t paid directly by consumers to the government, instead it’s included in the sale price and collected by businesses.

When a business is VAT-registered, it adds VAT to its sales (this is known as ‘output’ tax) and later passes that money to His Majesty’s Revenue & Customs (HMRC) through VAT returns. At the same time, the business can reclaim the VAT it pays on its own purchases (this is called ‘input’ tax). In the end, the business sends HMRC only the difference between the output tax and input tax, and the final consumer bears the cost of the tax.

For example, if you sell a product for £100 and add 20% VAT (£20), the customer pays £120. If you paid £10 VAT on the materials for that product, you’d owe HMRC £10 (because you collected £20 VAT but already paid £10 on inputs). If instead you paid more VAT on your expenses than you collected from sales, HMRC would refund you the difference.

VAT Schemes for small businesses.

Managing VAT can feel like a lot of admin, but HMRC offers a few simplified schemes that can make life easier for small businesses. The right scheme depends on your turnover and how you manage cash flow.

Flat Rate Scheme

Instead of working out the exact VAT on every sale and purchase, you pay a fixed percentage of your turnover to HMRC. The percentage depends on your industry. You still charge customers the standard VAT rate (usually 20%), but you pay HMRC less, and you keep the difference. You can’t reclaim VAT on most purchases, though. The Flat Rate Scheme is best if your business has relatively low expenses.

Cash Accounting Scheme

With cash accounting, you only pay VAT to HMRC when your customers actually pay you, and you reclaim VAT when you’ve paid your suppliers. This helps cash flow if you often wait a while for customers to settle invoices. To use this scheme, your VAT-taxable turnover must be £1.35 million or less.

Annual Accounting Scheme

Instead of filing quarterly returns, you make advance VAT payments throughout the year and then file one VAT return at the end. This reduces paperwork and helps with budgeting. It’s also available if your turnover is £1.35 million or less. Learn more about the Annual Accounting Scheme here.

VAT rates in the UK for 2026.

As of 2026, there are three main VAT rates in the UK:

  1. Standard rate = 20% This is the default VAT rate for most goods and services

  2. Reduced rate = 5% Applies on certain items like residential energy bills and children’s car seats.

  3. Zero rate = 0% On specific categories like basic food, children’s clothing, books and newspapers.

Additionally, some sales are VAT-exempt. For example, many financial services, insurance, and certain health and education services. No VAT is charged on exempt items, but if your business only sells exempt goods or services, you generally cannot reclaim VAT on your business purchases related to those sales. In contrast (and somewhat confusingly) zero-rated items do count as taxable sales, so a business selling zero-rated products can still reclaim VAT on its expenses. 

Note that the standard 20% VAT rate has been unchanged for many years, and there were no new VAT rate changes in 2025.

When and how to register for VAT.

The UK VAT registration threshold is £90,000 of VAT-taxable turnover in any 12-month period. If your business exceeds this threshold (or expects to in the next 30 days), you must register for VAT.

You can also register for VAT voluntarily, even if your turnover is below £90,000, for example to reclaim VAT on your business expenses. But note that once registered, you’ll have to charge VAT on your sales and take care of the ongoing reporting.

Registering for VAT is straightforward, and it’s done through HMRC’s website. Once HMRC approves your registration, they’ll issue you a VAT registration certificate with your VAT number and the date you’re officially VAT-registered. From that date, you need to start adding VAT to your taxable sales, and you can begin reclaiming VAT on your business purchases.

How VAT returns work and when they're due.

Each VAT return works out the difference between the VAT you’ve charged and the VAT you’ve paid on business expenses in the given period, typically quarterly.

You then pay HMRC the difference (or get a refund if you paid more VAT on purchases than you collected from sales). For instance, if you charged £500 in VAT to customers and paid £300 in VAT on expenses, you’d owe £200. If the opposite happened, HMRC would refund you the difference.

As of 2025, all VAT returns in the UK have to be filed online under HMRC’s Making Tax Digital system. You’ll need to keep digital records of your VAT transactions and use compatible software to submit your returns. VAT return deadlines are typically one month and 7 days after the period ends (for example, a quarter ending 31 March is due by 7 May). Missing a deadline can lead to penalties and interest, so make sure to submit and pay on time.

Charging VAT and reclaiming VAT.

Once you’re registered, you must add the correct VAT to your sales and clearly show it on any invoice, along with your VAT number. Most consumer prices are advertised inclusive of VAT, while business quotes or invoices often list the net price and then add VAT. 

On the other side, you can reclaim the VAT you pay on business purchases by subtracting that “input” VAT on your VAT return. Make sure any expense is purely for business use – if something is partly personal, you can only claim the business portion of the VAT. 

Also note that VAT on certain costs (for example, client entertainment) cannot be reclaimed. Keep all your receipts and invoices as proof in case HMRC needs to check your records.

Changes to VAT rules in 2025.

The VAT system in 2025 has a couple of updates that business owners should know about:

  • Higher registration threshold: The VAT registration threshold is now £90,000 (it was previously £85,000). This higher threshold means some small businesses can grow a bit larger before they are required to register for VAT. Keep an eye on your rolling turnover so you know if you’re approaching this limit.

  • New VAT on certain services: Starting from 1 January 2025, some things that used to be exempt from VAT have become taxable. A key example is private education fees – private schools now must charge the standard 20% VAT on tuition and related charges, whereas previously these were VAT-exempt. If your business is in a sector with special VAT treatments, make sure you’re aware of any rule changes affecting your industry.

Digital VAT and penalties: VAT reporting is now fully digital (MTD is mandatory). HMRC introduced a new points-based penalty system for late filings (effective from January 2023), and from April 2025, higher penalties and interest rates apply to late payments. In short, file and pay on time to avoid penalties.

Tips for staying VAT compliant.

Navigating VAT can be challenging at first, but these tips will help your small business stay on track:

  • Keep good records: Use software or digital tools to record all your sales and purchases, and make sure you apply the correct VAT rates. Good record-keeping makes filing returns easier and is required by HMRC’s digital rules.

  • Budget for VAT and stick to deadlines: Set aside the VAT you collect so you’re not caught short when it’s time to pay HMRC. It can help to keep the VAT portion in a separate bank account. Also, mark your VAT due dates on a calendar (remember the “1 month and 7 days” rule for quarter deadlines) and always file and pay on time to avoid penalties.

  • Ask for help when you need it: VAT can be complex, especially at first, so don’t hesitate to seek advice. HMRC’s guidance portal and helpline can clarify tricky rules, and accountants or bookkeepers can assist in managing your VAT. It’s better to get help than to make a costly mistake.

By understanding the basics of VAT and staying organised, VAT becomes a routine part of your business rather than a headache. With the current rules and rates in 2025, a little attention to detail will keep you compliant and free to focus on what you do best – running your business.


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FAQs

You don’t have to, but you can register voluntarily. The main benefit is being able to reclaim VAT on your business purchases, which can reduce costs if you spend a lot with VAT-registered suppliers. The drawback is extra admin: you’ll need to charge VAT on your sales, file VAT returns, and follow HMRC’s digital record-keeping rules. For some small businesses with mostly consumer customers, adding VAT can also make your prices look less competitive.

Zero-rated goods and services (like basic food, children’s clothes and books) are taxed at 0%. They still count as “taxable sales”, which means a business selling them can reclaim VAT on its own purchases. Exempt goods and services (like many financial services, insurance, and some healthcare and education) don’t have VAT charged, but they don’t count as taxable sales. If your business only makes exempt sales, you usually can’t reclaim VAT on your expenses.

For services sold overseas, the rules depend on where your customer is based and whether they are a business or a consumer. Generally, if you sell services to a business customer outside the UK, the supply is “outside the scope” of UK VAT – you don’t charge VAT, and the customer accounts for any local tax. If you sell to consumers outside the UK, UK VAT may apply unless specific exemptions exist. Make sure to check HMRC’s guidance for your service type and customer location, as the rules vary.

From 2025, HMRC uses a points-based system for late VAT returns. Each late submission earns a penalty point, and once you reach a set threshold, you face a fixed penalty. Late payments attract interest from the day after the due date, and since April 2025, higher penalty charges apply if you don’t pay within 15 or 30 days. In short, file and pay on time – otherwise you risk both fines and accumulating interest.

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