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Keeping track of your VAT liabilities is very important as you can face penalties if you get your VAT Returns wrong. For most traders it will be fairly straightforward - you simply pay the VAT charged on your sales and recover VAT deductible on your bought-in goods and services. However, complications can arise with some supplies and it is not always easy to decide on the VAT status of certain expenses. Therefore, you cannot simply go by your total inputs and outputs during the quarter. You need to keep a record of how you have calculated your VAT liabilities and how you have treated each transaction for VAT purposes. The best way of doing this is by using tax codes.

Most accounting software packages allow you to allocate a tax code to each transaction. This will enable the system to calculate the entries to go on your VAT returns. It will automatically calculate VAT on standard rated supplies and pick up input tax on allowable expenses. The tax codes and rates applicable to each code can usually be chosen by the user. Here is an example of a tax code table:

Tax Code Description VAT Rate
0 Outside scope 0%
1 Standard rated 20%
2 Reduced rated 5%
3 Zero rated 0%
4 Exempt 0%
5 Disallowable 0%
6 Not registered 0%
7 Group transaction 0%
8 Margin scheme 0%
9 Reverse charge 20%
10 Internal transaction 0%

It should be noted that the only VAT transactions that are truly 0% are zero rated supplies. Other categories are shown with a 0% rate purely as a system requirement (most software cannot process N/A in a numeric field).

There is an important difference between zero-rated supplies and exempt supplies. If you sell zero-rated goods or services, such as books or tickets for tourist attractions in other countries, you are entitled to recover all your input tax on all purchases relating to those supplies. If you sell exempt goods or services such as lottery tickets or insurance, you cannot recover input tax on purchases relating to those supplies. The distinction is only important if you make exempt supplies and are VAT registered, in which case your input tax will only be partially recoverable. However, there is no real need to distinguish between exempt and zero-rated purchases in your VAT records, although you might as well use the correct tax codes for them if you have set them up.

Reduced rate supplies include gas, electricity and other fuels supplied for domestic purposes, energy saving goods/services and certain products related to welfare, health or safety. A list of these can be found on the Revenue website together with exempt and zero rated supplies.

Transactions outside the scope of VAT include charitable donations, tolls for bridges and tunnels operated by public authorities and certain types of direct mail postal services. For most businesses, the only inputs to report under this code are wages and salaries paid to their own employees. Internal transactions will tend to be journals for accounting adjustments which have no VAT effect whatsoever.

Disallowable items will include any purchases on which you are not permitted to recover VAT as input tax even if it is shown on the invoice. The most common examples are business entertainment and non-business costs such as legal bills for non-trading activities. The other main area is rented property. If you receive rent from tenants and have not exercised your option to waive the VAT exemption on the let property, you must not claim input tax on any related expenses such as maintenance work, service charges, legal fees or consultancy fees.

It is good practice to separately identify purchases from suppliers who are not registered for VAT, even though in essence they are treated the same as exempt or zero-rated purchases. This helps to review your accounting records when you run VAT reports as it is easy to spot exempt or zero-rated items such as rent, publications and public transport but less easy to spot purchases from non-registered suppliers that would normally be standard rated. Taxi fares will normally come under this category unless you have a contract with a large taxi firm, in which case you will probably receive a monthly VAT invoice. If that is the case, you will need to analyse them between standard rated and zero rated supplies.

Group transactions will only occur if you are part of a VAT Group. If that is the case, inter-company transactions within the VAT group should be separately identified. So should margin scheme supplies such as TOMS if they apply to your business. With margin schemes you account for VAT on the profit rather than on the sales and acquisition costs separately, so it is important to exclude these from your other inputs and outputs. VAT on margin scheme supplies will need to be calculated separately.

Finally, do not forget Reverse Charges on foreign imports. If you receive goods or services from a supplier in another EU member state and it is zero-rated as you are a VAT registered business, you must account for output tax on it under the reverse charge procedure at the standard UK rate. You can also recover input tax on it as though UK VAT had been shown on the invoice, so in most cases the reverse charge will not increase your net VAT liability. Nonetheless you must account for the reverse charge anyway, so they do need to be picked up. And if you make exempt supplies and are only partially recoverable, then you will have an increased VAT liability so it is even more important to pick them up. Reverse charges also apply to foreign imports from non-EU countries although in most cases you will receive a VAT certificate from the Revenue allowing you to claim back input tax.

Acumen Accounting
2 Purley Bury Avenue, Purley Oaks, Surrey CR8 1JB
Tel: 020 3669 5270 Mobile: 07813 582890 E-mail:

For information of users: Although every care has been taken in compiling this material, it only provides an overview and does not take the place of an individual consultation. We strongly advise all users to consult the detailed legislation or seek professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or this firm.

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