Value-Added Tax (VAT) (also written as value-added tax or Value added tax) is a Consumption Tax charged on final consumption. It applies to goods and services at each production stage and throughout the supply chain, where “value” is added. Rather than charging tax only at the final sale, value-added tax is collected step-by-step, with businesses typically recovering VAT paid on business inputs as a tax credit.
VAT is a central part of the UK tax system and is administered by HM Revenue & Customs (HMRC), a UK tax authority, under the UK government. VAT is ultimately borne by the consumer as part of the tax burden, while businesses act as intermediaries that collect and remit VAT.
A key policy and enforcement topic in the UK is the VAT gap, i.e. the difference between the VAT that should be collected and what is actually collected. Reducing the VAT gap is a major objective of digital financial reporting↗, stronger tax compliance, and improved record-keeping.
What is Value-Added Tax
Value-Added Tax is an indirect Consumption Tax applied to most goods and services supplied by VAT-registered businesses in the UK. In practical terms:
- A VAT-registered business charges VAT on sales (its output tax).
- The business may reclaim VAT paid on purchases (its input tax) as a tax credit, subject to UK tax law and eligibility rules.
The “value added” is the difference between what a business sells and what it buys. Because eligible input tax is recovered, VAT is designed so that the total VAT collected across the supply chain equals VAT on final consumption.
How does VAT work?
VAT works through a system of charging, recording, and reclaiming tax at each step of the supply chain:
- Sales: A business charges VAT to the customer. This is output tax.
- Purchases: A business pays VAT to suppliers. This is input tax (often referred to as input VAT).
- Return filing: The business reports VAT due and VAT recoverable to the UK tax authority via tax returns.
A typical calculation is:
Output tax – input tax = VAT payable (or reclaimable)
Accurate tax calculations and correct categorisation of rates, reliefs, and exemptions are essential for UK tax compliance. Good reporting also helps reduce the VAT gap by making under-reporting and missing invoices easier to identify.
Who pays VAT?
Although businesses collect VAT, the final consumer pays it as part of the purchase price. Consumers cannot reclaim VAT, so VAT forms part of the overall tax burden on households.
Businesses that are VAT-registered typically recover eligible input tax via a tax credit. However, where VAT is non-recoverable (for example, restricted expenses or exempt activities), VAT can become a real cost to the business.
Small businesses may not need to register until they exceed a registration threshold. In the UK, this is commonly referred to as the VAT registration threshold and is based on taxable turnover (often linked to annual sales) over a set period. Exceeding the VAT registration threshold generally triggers VAT registration and the obligation to charge VAT and file tax returns.
VAT rates and categories in the UK
UK VAT includes different categories depending on the goods and services involved:
- standard rate: applies to most goods and services (the headline UK VAT rate is the standard rate).
- reduced rate: applies to specific categories (there may also be other reduced VAT rates for defined items).
- Zero-rated supplies: VAT is charged at 0%, but businesses can usually reclaim input tax.
- Exempt supplies: no VAT is charged, and businesses generally cannot reclaim input tax related to those supplies.
The distinction between zero-rated and Exempt supplies matters for cash flow↗ and how much input tax can be reclaimed.
Some categories, such as Healthcare services, commonly fall under special VAT rules in the UK and are often treated as exempt, depending on the circumstances and the provider.
VAT vs sales tax and goods and services tax
VAT is often contrasted with retail sales tax, where tax is charged only once at the final sale. VAT is collected across the supply chain, and the input tax credit mechanism prevents VAT from stacking at every step.
You may also see goods and services tax (GST) used in other countries. In many cases, goods and services tax works similarly to VAT within that country’s tax system, using comparable concepts such as input tax recovery and periodic reporting.
VAT registration and compliance in the UK
Once a business passes the VAT registration threshold (based on taxable turnover), it generally must complete VAT registration and meet ongoing tax obligations. These commonly include:
- Charging VAT on taxable sales
- Issuing VAT-compliant invoices
- Keeping VAT records and audit trails
- Filing periodic tax returns
- Paying VAT due to HMRC (the UK tax authority)
After VAT registration, a business is issued a VAT registration number, which must appear on invoices and certain VAT documents. Keeping the VAT registration number correct supports tax compliance and reduces avoidable disputes.
In the UK, Making Tax Digital is a key compliance programme affecting how VAT records are kept and how VAT information is submitted, aiming to improve accuracy and help reduce the VAT gap. VAT invoices are also key evidence for claiming eligible input tax—see how to fill an invoice↗.