What is VAT and how does it work? (2024)

What is VAT and how does it work? (1)What is VAT and how does it work? (2)Getty Images

Chancellor Rishi Sunak's cut to the rate of value added tax (VAT) on hospitality and tourism from 20% to 5% has now started.

It lasts until 31 March 2021 (it was originally due to end on 12 January, but the period has been extended) and applies to food and non-alcoholic drinks as well as accommodation and admission to attractions across the UK.

Mr Sunak said the move is designed to "get the sectors moving and to protect jobs", but what is VAT and how does it work?

What is VAT?

Value added tax, or VAT, is the tax you have to pay when you buy goods or services.

The standard rate of VAT in the UK is 20%, with about half the items households spend money on subject to this rate.

There is a reduced rate of 5% which applies to some things like children's car seats and home energy.

The lower rate also currently applies to sanitary products, although in the March 2020 Budget, the government announced it will stop charging VAT on these goods from 1 January 2021.

When you see a price for something in a shop, any VAT will already have been added.

There are also various items for which you do not have to pay any VAT, such as most supermarket food, children's clothing, newspapers and magazines.

How much money does VAT raise?

The Office for Budget Responsibility (OBR) predicted in March that VAT would raise £136.6bn in 2019-20.

That is equivalent to around £4,800 per household and represents 16.8% of all the money the government receives from taxes.

What is VAT and how does it work? (3)What is VAT and how does it work? (4)

How does this compare to other taxes?

In 2018-19 VAT was the third biggest income generator for the UK government, after income tax and national insurance contributions.

For most families in the UK, income tax is the single biggest tax they pay. You can see that in the dark green bars in the chart below.

But poorer households tend to pay a bigger share of their taxes through taxes on spending: VAT and duties - the blue areas in each bar. Those are known as indirect taxes.

For the poorest fifth of households, VAT is the biggest single tax that is paid.

What is VAT and how does it work? (5)What is VAT and how does it work? (6)

How has VAT changed over time?

The standard rate of VAT increased from 17.5% to 20% on 4 January 2011.

In 2008, following the financial crash, the government introduced a temporary cut in the rate of VAT to 15%.

The rate cut lasted from 1 December 2008 to 31 December 2009 and cost the government £12.4bn in lost revenue.

The aim of the cut was to boost consumer spending with retailers expected to pass the reduction on to customers.

At the time, opinion was divided about the policy with then Conservative leader David Cameron calling it an "unbelievable and expensive failure".

The Institute for Fiscal Studies was more supportive. It predicted a growth in sales of about 1% and said a VAT cut compared well with other incentives.

Measuring the overall impact proved challenging, because no-one could know what would have happened without the rate cut.

Mr Sunak's six-month cut for hospitality and tourism is set to cost the government £4.1bn.

Are companies passing on the VAT cut to customers?

The Treasury estimates households could save £160 a year on average, but not all firms will pass on the benefit.

Many companies are expected to use the windfall to shore up finances hit by the lockdown, rather than cut prices.

For example, Malcolm Bell, chief executive of Visit Britain, said the chancellor's move was to support business, not help holidaymakers.

And many attractions such as museums, parks and zoos, might also not pass on the reduction.

However, Starbucks has said it will pass on the full 15% discount on coffee served in company-operated stores.

McDonald's has recommended that its franchisees cut prices on an array of products, and pub chain Wetherspoon said it would reduce prices on meals, coffee and soft drinks.

How does the UK compare to other countries?

The UK's VAT rate of 20% seems to be roughly in the middle when compared with European Union countries.

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What is VAT and how does it work? (2024)

FAQs

What is VAT and how does it work? ›

A value-added tax (VAT) is paid at every stage of a product's production from the sale of the raw materials to its final purchase by a consumer. Each assessment is used to reimburse the previous buyer in the chain. So, the tax is ultimately paid by the consumer.

Can US citizens get VAT back? ›

It's a sales tax paid by consumers (not businesses), and it doesn't exist in the United States. Only visitors—including U.S. tourists—are able to qualify for a VAT refund.

How does VAT work in the USA? ›

No, the United States has no VAT. The federal government raises money primarily through the income tax system. The states and local governments establish and collect their own sales taxes. Local governments rely primarily on property taxes.

Who needs to pay VAT? ›

Businesses must register for VAT whether they are incorporated or are sole traders, whether they pay corporation tax or not. Businesses with revenue below this threshold may also benefit from registering for VAT. VAT registration allows businesses to reclaim VAT on goods and services purchased by your business.

What does VAT mean in simple terms? ›

VAT (Value Added Tax) is a tax added to most products and services sold by VAT -registered businesses.

Do I pay VAT if I buy from USA? ›

If customs taxes are due, your courier will contact you with information and costs, but you may also be charged VAT and/or excise duty as well. VAT is charged on most goods at the standard rate of 20%, but some goods may be eligible for a reduced rate at 5% or even zero-rated at 0%.

Do US residents have to pay VAT? ›

The United States is in the minority of countries that don't levy a value-added tax, though most states have a sales tax that serves the same purpose.

How do I claim VAT back? ›

Claiming back VAT involves completing a VAT Return – usually each quarter. If completing the VAT Return form online on HMRC's website, you must enter how much VAT your business was charged in that three-month accounting period for goods and services you are able to claim VAT on. This is known as input VAT.

How to avoid paying VAT? ›

VAT disaggregation is one way of staying under the VAT registration threshold by effectively splitting your business up, so that the revenue of each part stays below the threshold.

How much VAT do Americans pay? ›

World VAT/GST rates 2024
CountryStandard VAT/GST Rate
UruguayThe standard VAT rate is 22%
USAThere is no VAT in the USA. U.S. state sales and use tax rates vary between 2.9% and 7.25%
UzbekistanThe standard VAT rate is 12%
VanuatuThe standard VAT rate is 15%
84 more rows
5 days ago

What is VAT for dummies? ›

VAT stands for value added tax and it's a type of indirect tax. Indirect tax means that the payment of tax is passed onto another entity. So, let's say your business is VAT registered. You add VAT to your sales invoices and send them to your clients.

What goods are exempt from VAT? ›

Examples of VAT exempt goods and services
  • insurance, finance and credit services.
  • education and training services.
  • charitable fundraising events.
  • subscriptions to membership organisations.
  • selling, leasing and letting of commercial property, however this exemption can be waived.
Jul 1, 2024

How do I know if I need VAT? ›

Typical instances where a business is required to register for a local VAT number include:
  • If a foreign company is buying and selling goods in another country.
  • If a company is importing goods into an EU country, which can include moving goods across national borders within the EU.

Who is responsible for paying VAT? ›

The vendor is required to pay the difference between the output tax and the input tax or claim a VAT refund where the input tax exceeds the output tax. VAT is therefore, charged at each stage of the production and distribution process and it is proportional to the price charged for the goods and services.

Who pays VAT taxes? ›

Key Takeaways. A value-added tax (VAT) is paid at every stage of a product's production from the sale of the raw materials to its final purchase by a consumer. Each assessment is used to reimburse the previous buyer in the chain. So, the tax is ultimately paid by the consumer.

Is VAT the same as sales tax? ›

A VAT is like a sales tax in that ultimately only the end consumer is taxed. It differs from the sales tax in that, with the latter, the tax is collected and remitted to the government only once, at the point of purchase by the end consumer.

Can I claim my VAT back? ›

What can you reclaim VAT on? You can only reclaim VAT on goods and services that were exclusively used for your business. You can't reclaim VAT on goods and services that are for non-business use or are for client entertaining. You also can't claim for services that are exempt from VAT, such as insurance.

Can I claim sales tax back in the USA? ›

Generally, no refund of sales tax is available if you took possession of the item from the vendor with a given state. In the United States, sales tax is imposed at the point of transfer of title or possession.

Can you claim VAT after leaving country? ›

You must show the invoice, the refund form, the goods and any other necessary documents to the customs officers of the last EU country you leave. The customs officers must stamp the form as proof of export. Without the stamp, you will not obtain the refund.

How to claim tax back from shopping in the USA? ›

Requirements to Get a Sales Tax Refund
  1. Minimum purchase: There is a minimum tax required per receipt from a brand retail or outlet store, depending on the state. ...
  2. Timeliness of purchase: It is important to ensure the timeliness of your purchase when seeking sales tax refunds or exemptions as an international visitor.
Jun 5, 2024

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