UK VAT — what every SME owner needs to know
Value Added Tax (VAT) is a consumption tax charged on most goods and services sold in the UK. As a VAT-registered business, you collect VAT from your customers (output VAT) and reclaim VAT on your purchases (input VAT). The difference is what you pay — or reclaim — from HMRC each quarter.
The three VAT rates in 2025/26
Standard rate (20%) applies to most goods and services. Reduced rate (5%) applies to items like domestic energy, children's car seats, and some home energy efficiency products. Zero rate (0%) applies to most food, children's clothing, books, and passenger transport — zero-rated goods are still VATable, which means you can reclaim input VAT on related purchases.
The £90,000 registration threshold
You must register for VAT once your taxable turnover exceeds £90,000 in any rolling 12-month period. The clock starts when you exceed the threshold — you then have 30 days to register, and must start charging VAT from the first day of the next month. Late registration carries penalties.
Standard scheme vs Flat Rate Scheme
The standard scheme requires you to track input and output VAT on every transaction. Most businesses use this. The Flat Rate Scheme (FRS) lets you pay a fixed percentage of your gross turnover to HMRC instead. You cannot reclaim input VAT on most purchases, but you keep any difference between the flat rate you pay and the 20% you charge customers.
FRS works best for service businesses with low VATable costs. If you spend significantly on materials or stock, the standard scheme almost always wins. The FRS threshold is £150,000 net turnover to join; you must leave if gross turnover exceeds £230,000.
Limited cost trader: If your VATable goods purchases are less than 2% of gross turnover (or below £1,000/year), you’re classed as a limited cost trader and must use the 16.5% flat rate — typically less beneficial than the standard scheme for consultants and knowledge businesses.
Cash accounting vs accruals for VAT
Under the standard scheme, you can choose cash accounting — paying VAT only when you’ve actually received payment, not when you invoice. This is highly beneficial for businesses with slow-paying customers, as it eliminates the cash flow risk of paying VAT on unpaid invoices. Eligible if your turnover is below £1.35m.
Making Tax Digital for VAT
All VAT-registered businesses must now keep digital records and file VAT returns using MTD-compatible software. HMRC no longer accepts manual VAT returns. Compatible software includes Xero, QuickBooks, Sage, and FreeAgent. You must also keep a digital audit trail linking source transactions to the VAT return.