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What is VAT exemption?

May 9, 2022
If you take a look at the receipts of items you've purchased as of late, you might find VAT added on at the end. You might find the amount of VAT charged changes depending on what you've bought — but what happens when items aren't charged VAT?
For items classified as VAT exempt, there is no need to charge VAT. However, if you know a thing or two about VAT rates, you might be wondering how VAT exemption differs from zero-rate VAT and what, if you're a VAT-registered business owner, this means for your small business.

We'll be covering everything you need to know about VAT exemption, from which items classify as VAT exempt, what happens if you sell both VAT rated and VAT exempt items, and what it means to be a VAT exempt business.

What is VAT?

VAT, or Value Added Tax, is a consumption tax applied to certain taxable goods and services — known as ‘taxable supplies’ — and is charged at every stage of the supply chain. Input tax is paid on the goods and services you pay suppliers, whereas output tax is the VAT you charge customers on the products you sell.

It's important to note that only VAT-registered businesses can charge output tax, but you don't have to be VAT-registered to pay input tax.Unless you're registered for a specific VAT payment scheme that states otherwise, such as the Flat Rate Scheme, every 3 months you'll need to file a VAT return to HM Revenue and Customs (HMRC) that totals both your output VAT and input VAT.The idea here is that ultimately you break even — either you pay forward the excess VAT you've made to HMRC, or reclaim the VAT that you've missed out on when you file your VAT return.
Diagram showing how input VAT and output VAT work

What is VAT exemption?

However, not every item is subject to VAT and is therefore VAT exempt. This means that VAT cannot be charged on exempt supplies, and therefore won't be considered as part of your taxable turnover.
VAT exemption occurs when a business solely sells VAT exempt goods and services. VAT exempt sales aren't counted when working out your VAT taxable turnover, so if your business only sells VAT exempt items your business won't ever come close to surpassing the VAT threshold (which, at the time of writing, is £85,000). As a result, you won't be able to register your business for VAT.

Which goods and services are VAT exempt?

HMRC classifies the following goods and services as VAT exempt:
    Insurance, finance and creditEducation and trainingFundraising events by charitiesSubscriptions to membership organisationsSelling, leading and letting of commercial land and buildings (although this exemption can be waived)Fundraising events by charitiesThe services of doctors and dentists

What does VAT exemption mean for my business?

If your business solely provides the above goods and services, you cannot register for VAT and are therefore a VAT exempt business. As a result, you cannot charge customers VAT, and you cannot reclaim VAT from HMRC.For instance, healthcare and health services provided by doctors are VAT exempt, but may still require an accountant or accounting software (or a combination of both) that'll charge a standard rate of VAT. In this case, despite paying the VAT, since these services are not VAT registered they cannot reclaim the VAT they pay.

VAT exemption, zero-rated and 'out of scope'

To make your tax return slightly more confusing, you might also find yourself selling zero-rated or 'out of scope' goods and services, which along with VAT exempt items, aren't charged VAT.However, despite the consumer paying no VAT when making a purchase, the goods and services that fall under these categories each appear differently on a VAT return, so familiarising yourself with the finer details can save you from making mistakes further down the line.

Out of scope

The most similar to VAT exemption, goods and services considered 'out of scope' fall outside of the UK VAT tax system. As a result, these items are VAT-free and you cannot charge or reclaim VAT on these items.Out of scope items include:
    Goods or services bought and used outside of the UKStatutory fees, such as the London congestion chargeGoods you sell as part of a hobby, such as stamps from a stamp collectionDonations to charity if given without receiving anything in return

Zero-rated

While customers won’t pay VAT on any zero-rated goods they buy, unlike VAT exempt and out of scope items, zero-rated goods are charged a rate of VAT — 0%. This means that even if you only sell zero-rated items from your business, if your taxable income is above the VAT threshold you'll need to register for VAT, or you can register voluntarily before you reach the threshold.

The following items are charged 0% VAT:
    Books and newspapersChildren's clothes and shoesMotorcycle helmetsMost goods exported from England, Wales and Scotland to a country outside of the UKMost goods exported from Northern Ireland to a country outside of the UK and EU
Here's where things get interesting. While only selling zero-rated goods does not make you VAT exempt automatically — meaning you'll need to record these items in your VAT accounts and returns — you can apply for VAT exemption. For more information, read paragraph 3.11 of VAT Notice 700/1 on the HMRC website.

Should I apply for VAT exemption?

If you're eligible to apply for VAT exemption, the decision as to whether or not you apply is yours alone to make.
However, to help you come to a conclusion, we've listed out some pros and cons of VAT exemption below, and if you're really stuck you can book a one-off call with one of our accountants for advice.

Benefits of VAT exemptionDrawbacks of VAT exemption
    You don't need to worry about keeping VAT returns No need to keep VAT records You don't charge customers VAT, meaning you can offer lower prices You can save money on the items you purchase for your business (only if your supplier is VAT exempt) Being VAT registered and having a VAT registration number visible on your company website can make your business more credible
    You cannot reclaim any VAT you pay to VAT registered businesses (unless the VAT is below a certain limit Some businesses may prefer to trade with VAT registered businesses, and as a result you may lose out on clients

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