What Is VAT Calculation, And How To Do It?

If you have a VAT-registered business in the UK, you must comply with the rules and regulations for adding VAT to your sales prices.  

In this regard, we offer an in-depth guide on VAT to help you stay on the right side of the law.

In the following sections, we explain what VAT is, what VAT calculation means, in which cases you are legally required to charge VAT as a business, and more.

What is a VAT calculation?

Before we can explore what calculating VAT means, it’s essential to understand the definition of VAT.

In short, VAT stands for Value Added Tax. It is an indirect consumption tax enforced on the value added to goods and services throughout multiple phases of the supply chain. Therefore, it ultimately affects the total amount customers have to pay. 

In other words, VAT is a tax applied on top of the sales price that VAT-registered businesses can claim. 

Countries that are part of the European Union are required by law to implement a minimum VAT rate.

Why is VAT charged?

The main purpose behind VAT is to raise government revenue. 

Initially, the VAT system was created as a simpler alternative to sales and gross turnover tax. 

Value Added Tax is much more transparent, making it quick and easy to track compared to other taxes. This is mainly due to the fact that it’s accumulated throughout each phase of the supply chain. 

In addition, all businesses are obliged to keep a record of all purchases, sales, and supplies.

When should you charge VAT?

Businesses must charge VAT if they’re VAT-registered.

In the UK, companies whose annual turnover exceeds £90,000 must register for VAT. 

The registration takes place with HMRC, after which the company can add VAT on the products and services it sells to customers or other businesses.

As you know, each business is charged a specific amount for the products and services it purchases. It can reclaim the VAT, acting as a tax collector to some extent.

How to calculate VAT?

One of the easiest methods for calculating VAT is via a VAT calculator. 

To do so, you must open an online VAT calculator and select the VAT rate that applies to the product or service. 

As a result, the calculator will inform you of the following information:

• The net amount –  this net figure represents the cost of your item.
• The gross amount – the gross amount is the cost of your item, including VAT. This is the amount that businesses reveal to customers or consumers in the form of a product price.
• The total VAT amount – a figure that portrays the total price that the business will be held responsible for in the form of tax paid to the HMRC. In other words, the total VAT amount demonstrates how much VAT is owed. 

Some VAT calculators enable businesses to change VAT rates, add tax to a net amount, or subtract VAT from a gross amount in seconds. 

If you decide to calculate VAT manually, you only need to add the VAT rate to the product’s or service’s price. Simply multiply 1.2 by the price you charge (if the applicable VAT rate is standard or 20%). 

For instance, imagine that you sell office accessories for £100. Multiply £100 by 1.2 to receive 120. In this case, £120 is the new price after the added tax. 

When invoicing and issuing receipts, you need to include the original product price (£100), the VAT (£20), and the price including VAT (£120).

The same example can be explored for products or services where the VAT rate is 5% instead of 20%. Instead of multiplying the price by 1.2, you’ll need to multiply by 1.05.

What is needed to calculate VAT?

If you’re calculating VAT for your business, you’ll need two key components: the amount and the VAR rate.

Amount

The amount component used for calculating VAT represents the amount to which the VAR is applied. 

In other words, it’s the price of the product or service before adding VAT or the price excluding VAT.

VAT rate

On the other hand, the VAT rate portrays the VAT percentage that must be added to the original amount. 

In the UK, VAT rates can differ based on the products or services sold. For example, a standard rate, a reduced rate, and a zero rate can apply to your business. 

The standard VAT rate in the UK is 20%. This sales tax applies to most goods and services, making it popular for most businesses. 

On the other hand, the reduced rate applies to specific products and is 5%. Some examples of items where the tax applied is 5% include caravans, smoking cessation items, and specific energy-saving materials. 

Finally, some goods and services attract a 0% VAT rate. These include kids’ clothing and shoes, books, magazines, and equipment or accessories for disabled individuals. 

It is important to know that adding a 0% VAT rate on any invoice you issue as a business (in case the zero rate applies) is mandatory, although this zero rate does not impact the price that includes VAT.

What is included in the VAT calculation?

To summarise the points above, we can conclude that when calculating VAT, you’ll need some essential components.

They are as follows:

• The amount: This is also referred to as the taxable value, representing the price of products or services before VAT is added.
• The VAT rate: Based on the types of goods and services you sell, you’ll need to understand the VAT rate that applies to your business (either 20%, 5%, or 0%).
• VAT amount: You’ll also need to consider the actual tax owed on the transaction, which is the VAT amount. This value is calculated as a percentage of the taxable value. 
• Invoice amount: The total invoice amount represents the sum of the taxable value and the VAT amount. It demonstrates the total price that the consumer pays when purchasing your product or service. The invoice amount includes both the cost of the product or service and the included VAT. 

By having all of this information, you can calculate your VAT and ensure that your invoices are created according to UK regulations.

What is excluded from VAT calculation?

Certain products or services are excluded from VAT in the UK and, therefore, from VAT calculation. 

These include:

• The majority of financial and insurance services, in addition to lending, borrowing, and currency exchange;
• Education and training goods and services;
• Healthcare services;
• Specific cultural and sporting activities; 
• Children’s clothing and footwear;
• Books and newspapers;
• Public transport fares;
• Postal services;
• Property transactions;
• Government and public services. 

The examples above are part of a broader list of goods and services exempt from VAT.

Conclusion 

If you’re a VAT-registered business, paying close attention to VAT rates and calculations is crucial. Failing to do so can potentially lead to hefty fines and legal conflicts. 

Understanding in-depth how VAT works and how to calculate Value Added Tax is not something that only the accounting department in your company should be aware of. By having basic knowledge of this type of tax, you can ensure that your practices comply with the law and avoid any unexpected situations.

Frequently Asked Questions

How does VAT work?

VAT or Value Added Tax is charged as a percentage of the selling price of products or services. Businesses collect VAT on their sales and subtract the VAT they have paid on their purchases. The difference between these two components is paid to the tax authorities.

Who is required to register for VAT?

In the UK, your business must register for VAT if, by the end of any month, your annual turnover exceeds £90,000.

Are there any consequences for VAT non-compliance?

Yes, penalties and other consequences are associated with non-compliance with VAT regulations. Some of these include interest charges, fines, and possibly even legal action.