AAT Level 2 Chapter 3 - Introduction to VAT

Definition - a form of indirect taxation levied on most business to business and business to consumer transactions. It is levied at each stage in the chain of production and distribution from raw materials to the final sale based on the value (price) added at each stage. It is not a cost to the producer or the distribution chain members, and whereas its full brunt is borne by the end consumer.

• Goods and services liable to VAT are known as 'taxable supplies'.
  
• Where the taxaxble turover exceeds a certain limit known as the 'VAT threshold', then the business must register for VAT.
• Once registered for VAT a business has certain responsibilities, these include: charging the right rate of VAT, keeping VAT records and a VAT account, submitting VAT returns on time and paying any VAT due to HMRC on time.

• Standard Rate - currently 20% - most goods and services are subject to this rate of VAT.
• Reduced Rate - currently 5% - examples include: domestic fuel and power, residential property conversions and children's car seats.
• Zero rate - 0% - examples include: essential food, books and newspapers, children's clothing and footwear and public transport.

Exempt items

• Royal mail stamps and postage
• Insurance
• Rent on commercial premises
• Providing credit
• Education and training

Items outside the scope

• Rates
• Wages
• Salaries
• Donations to charity

• Input tax - VAT reclaimable by businesses from HMRC on VAT they themselves have paid in their production process.
• Output tax - charged on the selling price of taxable goods and services, and is payable by the customer.

• Where output tax exceeds input tax the difference is paid over to HMRC:

For example: Output tax = £25,000.00     Input tax = £18,000.00     Difference = £7,000.00

Therefore £7,000.00 is paid to HMRC

• Where input tax exceeds output tax the difference is reclaimed from HMRC:

For example: Output tax = £16,000.00     Input tax = £20,000.00     Difference = £4,000.00

Therefore £4,000.00 is reclaimed from HMRC

Gross value of goods or services - value including VAT
Net value of goods or services - value excluding VAT

The formula for calculating VAT to be added to the net value of goods or services:

VAT amount = net value x VAT percentage rate (20%)

The formula for calculating VAT at standard rate on the gross value of goods or services:

VAT amount = 20/120 x total amout paid

The VAT fraction used to calculate the VAT content and net goods value on the gross value of goods or services:

  VAT amount  = gross value divide by 1/6

The net goods value content is therefore:

Net goods = gross value - VAT amount

• Accounting for VAT requires that the VAT value of a transaction is posted to a VAT account, also referred to as the VAT control account.

On balancing off the VAT account the account will either carry a debit (DR) or credit (CR) balance:

• A debit balance represents an asset to the business and occurs when the input tax posted to the account exceeds output tax. There for a debit balance on the VAT account is an amount owed to the business by HMRC because they can reclaim the excess input tax back.
• A credit balance represents a liability to the business and occurs, when at the time of balancing off the account, output tax posted to the account exceeds input tax. The credit balance therefore represents an amount owed to HMRC by the business because excess ouput tax must be paid over to HMRC.