Zero-rated VAT: Everything you need to know about this VAT paradox

Zero-rated VAT… Sounds a bit impossible, doesn’t it? If VAT rates are zero then surely the VAT  doesn’t exist?

And whilst we’re here, how on earth are zero-rated VAT items different from items that are VAT exempt?

Not only is zero-rated VAT different from being VAT exempt it can actually be beneficial to your business model and cash flow.

Keep reading to learn all about VAT, zero-rate VAT and why it’s not the same as being VAT exempt.

What is VAT and how does it work?

VAT is a tax that the government adds to most products and services. Businesses add an extra VAT charge, collect it, and send it to the government. That's why you may hear VAT called a consumption tax or an indirect tax on the buyer.

There are many rules and regulations about VAT, like only businesses and people who make more than £85,000 a year must register and pay it.

The standard VAT rate for businesses in the UK is 20%, but this rate changes based on the good or service you’re providing and a number of other factors.

Other rates of VAT include:

• Reduced-rate VAT, which is often 5%
• Zero-rated VAT, which is (you guessed it) 0%

What is zero-rated VAT?

Zero-rated VAT means there are certain goods and services which the government is currently charging 0% VAT on.

Zero-rated supplies can include things like food, advertising for charities, equipment for disabled people, books and newspapers.

Even though you’re being charged 0% you must still record sales of zero-rated VAT items or services, and report them on your VAT return.

Economically zero-rated VAT exists to give consumers financial relief on essential basic items.

What goods and services fall under zero-rated VAT?

Some of the most common  zero-rated supplies include food, drinks, prescription drugs, children’s clothes and footwear.

For a closer look at what other zero-rated VAT items  take a look at our handy table below, or hop on over to the government’s website to see the list in full.

Charities

• Advertising services for charities
• Certain goods sold at charitable fundraising events
• Charity shops — selling donated goods
• Construction and sale of new buildings for a relevant charitable purpose

Welfare

• Building services for disabled people
• Equipment for blind or partially sighted people
• Equipment for disabled people
• Magnetic tape adapted for recording speech for blind people together with apparatus for making and playing the adapted tape and certain low vision aids

Health

• Dispensing of prescriptions by a registered pharmacist
• Incontinence products
• Maternity pads
• Sanitary protection products
• Low vision aids

Utilities

• Cesspools, septic tanks or similar (domestic) — emptying
• Sewerage services supplied to domestic or industrial customers
• Water supplied to households

Energy-saving materials* 

*installed in dwellings and buildings used for a relevant residential purpose

• Air source heat pumps
• Boilers — wood fuelled
• Central heating and hot water controls
• Draught stripping
• Ground source heat pumps
• Insulation
• Micro combined heat and power units
• Solar panels
• Water and wind turbines

Building and construction

• Substantial reconstructions to protected buildings that are buildings used as a dwelling, for a relevant residential purpose or for a relevant charitable purpose
• The installation of a bathroom or lavatory, constructing ramps and widening doorways or passageways for disabled people in their own home
• Construction and first freehold or long leasehold sale of a new building for a relevant charitable purpose
• Construction and first freehold or long leasehold sale of a new building for relevant residential purposes
• Construction and first freehold or long leasehold sale of new domestic buildings
• First freehold or long leasehold sale of a commercial building converted into a dwelling or dwellings
• First freehold or long leasehold sale of buildings converted for relevant residential purposes
• First freehold or long leasehold sale of buildings converted for relevant charitable purposes

Land and property

• Sale or long lease of a new dwelling with garage or parking space

Transport

• Aircraft repair and maintenance

Freight

• Freight transport to or from a place outside the UK
• Freight containers — sale, lease or hire to a place outside the UK and the EU
• International freight transport that takes place in the UK and its territorial waters

Travel

• Passenger transport in a vehicle, boat or aircraft that carries not less than 10 passengers

Vehicles

• Aircraft repair and maintenance
• Airships — sale or charter
• Caravans (more than 7 metres long or more than 2.55 metres wide)
• Civil aeroplanes — sale or charter
• Helicopters — sale or charter
• Houseboats — sale or let out on hire
• Military aeroplanes — sale or charter
• Ship repairs and maintenance
• Shipbuilding — 15 tons or over gross tonnage

Printing

• Printing brochures
• Printing Leaflets
• Printing Pamphlets

Publications

• Books
• Children’s painting and picture books
• Maps and charts
• Magazines
• Newspapers
• Printed or copied music
• Publications

Clothing and footwear

• Babywear
• Children’s clothes and footwear

Protective and safety equipment

• Cycle helmets — CE marked
• Motorcycle helmets that meet safety standards
• Protective boots and helmets for industrial use

What conditions do I need to meet for these rates to apply?

Whether you’re eligible for zero-rated VAT will depend on a number of factors, like whether you’re registered for VAT and whether the goods and services you provide are eligible.

Some other factors you’ll need to consider are:

• Who’s providing or buying the goods or services
• Where they are provided
• How they are presented for sale
• The precise nature of the goods or services
• Whether you obtain the necessary evidence
• Whether you keep the right records, and whether they are provided with other goods and services.

There are also specific VAT rules for certain trades that affect:

• How you account for VAT
• How much you must pay
• How much you can reclaim

To make sure that you meet the conditions for the reduced rate of VAT, consult HMRC’s website and read their guidance, called a VAT notice, on your specific industry.

What’s the difference between zero-rated VAT and exempt items?

A zero-rated VAT item is an item that falls within the VAT scheme but the VAT charge is 0%. So reclaiming VAT on zero-rated supplies is still an option if you’ve bought things necessary for your business that year. 

This has massive implications for your cash flow and supply chain as you can claim more money back through this rate.

Whereas when it comes to exempt items you do not have to charge VAT, but you also cannot reclaim any VAT you pay. You still have to record exempt items on your VAT return though.

For example, if you're a company selling equipment to blind or partially sighted people you will not charge your customers VAT. This makes this equipment 20% cheaper for blind or partially sighted people. But you may have to pay the standard rate of VAT, an extra 20%, for the materials or tools you buy to make your equipment.

When it comes to your VAT return you can claim that back from the government, even though you won't be giving anything to HMRC from your sales. Whereas if you're exempt from VAT you can neither charge VAT nor reclaim VAT.

Reclaiming VAT on zero-rated supplies is what makes the zero rate such a favourable tax rate. You can claim all the benefits without the drawback of charging your customers extra.

How to account for and reclaim zero-rate VAT

You can account for and reclaim the zero-rate of VAT in the same way you would approach other VAT rates.

To keep your VAT accounts in order you must keep a record of the following according to HMRC:

• Everything you buy and sell (including zero-rated, reduced and exempt items)
• Copies of all invoices you issue
• All invoices you receive (originals or electronic copies)
• Self-billing agreements (where the customer prepares the invoice)
• The name, address and number of any self-billing suppliers VAT
• Debit or credit notes
• Any goods you give away or take from stock for your private use

Businesses must also keep a record of the VAT they have charged and the amount they have reclaimed. This record must be easily retrievable and available for inspection.

Bear in mind the government’s Making Tax Digital initiative; unless you are exempt you must keep detailed and extensive digital records on appropriate software as well.

Pleo can help you keep track of your VAT

Our automated invoice software keeps helps you retain all the evidence you need to pay VAT or show that you’ve accurately reversed it. You can even integrate it with your accounting system of choice, from Sage to Quickbooks.

Pretty cool? We think so too.

Try automating your invoices with Pleo today.