Beginner's Guide To How UK VAT Works

BEGINNER’S GUIDE TOHOW VAT WORKSfrom titanlearning.

V A T

VAT is an indirect multi-stage sales tax on the consumption of goods and services

ALUE

DDED

AX

Stage 1

Stage 2

Stage 3

VAT

VAT

VAT applies to each stage of theproduction chain

Business A

Business B

Business C

VAT

VAT

Each business charges VAT to it’scustomers...

CHARGES

CHARGES

Business A

Business B

Business C

VAT

VAT

... and each business can deductVAT that it is charged.

DEDUCTS

DEDUCTS

Business A

Business B

Business C

VAT

VAT DEDUCTS

DEDUCTS

CHARGES

CHARGES

Let’s use the production chain for a chair as an example

All stages of the production chain are in the UK

Stage 1: Woodcutter

A woodcutter cuts logs from the forest tosell to his customer - a factory.

He makes the following sales

40 Logs sold to the Factory £200

10 Logs sold to the Factory £50

20 Logs sold to the Factory £100

Stage 1: Woodcutter

The woodcutter has to charge UK VAT(20%) on his sales.

Woodcutter’s Taxable Sales

Total Net Taxable Sales £350

Total Output VAT £70

40 Logs sold to the Factory £200 + £40 VAT

10 Logs sold to the Factory £50 + £10 VAT

20 Logs sold to the Factory £100 + £20 VAT

Stage 1: Woodcutter

The woodcutter can also deduct anyVAT charged on his taxable costs.

Woodcutter’s Taxable Costs

Total Net Taxable Costs £80

Total Input VAT £16

Fuel for tractor £20 + £4 VAT

Fuel for chainsaw £10 + £2 VAT

Hand tools £50 + £10 VAT

Stage 1: Woodcutter

The woodcutter can set off VAT incurred against VAT charged.He must declare the difference of £54 on his VAT Return.

Remitted VAT to HMRC

Total Input VAT -£16Total Output VAT £70

VAT Remitted to HMRC £54

Stage 2: Factory

A factory buys timber from the woodcutter to turn intofurniture, which is then sold to a retailer

The factory is adding value to the supply chain.

Stage 2: Factory

Factory’s Taxable Costs

40 Logs from Woodcutter £200 + £40 VAT10 Logs from Woodcutter £50 + £10 VAT20 Logs from Woodcutter £100 + £20 VAT

Total Net Taxable Costs £350

Total Input VAT £70

Factory’s Taxable Sales

Total Net Taxable Sales £1,200

Total Output VAT £240

Furniture to Retailer £500 + £100 VATFurniture to Retailer £300 + £60 VATFurniture to Retailer £400 + £80 VAT

Remitted VAT to HMRC

Total Input VAT -£70Total Output VAT £240

VAT Remitted to HMRC £170

Stage 3: Retailer

A retailer buys wholesale furniture from the factory to sell on tothe consumer. The retailer is the last stage of the supply chain

Stage 3: Retailer

Retailer’s Taxable Costs

Furniture for Retail £500 + £100 VATFurniture for Retail £300 + £60 VATFurniture for Retail £400 + £80 VAT

Total Net Taxable Costs £1,200

Total Input VAT £240

Retailer’s Taxable Sales

Total Net Taxable Sales £2,300

Total Output VAT £460

Furniture Sales £1000 + £200 VATFurniture Sales £550 + £110 VATFurniture Sales £750 + £150 VAT

Remitted VAT to HMRC

Total Input VAT -£240Total Output VAT £460

VAT Remitted to HMRC £220

Stage 3: Retailer

The retailer can deduct the VAT on his taxable costs (£240) and must declare the Output VAT of £460. The retailer must

declare VAT of £220 on his VAT return to HMRC.

Remitted VAT to HMRC

Total Input VAT -£240Total Output VAT £460

VAT Remitted to HMRC £220

Stage 3: Retailer

The VAT charged by the retailer cannot be deducted by theconsumer as the VAT ‘sticks’ with the end consumer in

the supply chain.

TAX AUTHORITY - HMRC

VAT Collected from Businesses:

Output VAT from Woodcutter’s Suppliers £161

Woodcutter £54Furniture Factory £170Furniture Retailer £220

Total VAT Collected £4602

2 The total VAT collected matches the VAT charged to the end consumer

TOTAL REMITTED VAT

1 The £16 of Input VAT incurred by the woodcutter would have been paid over to

HMRC pay his suppliers as part of a different supply chain.

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