The value-added tax was introduced in the United Kingdom in 1973, replacing Purchase Tax, and is the third-largest source of government revenue after National Insurance and Income Tax. It is managed and collected, mainly through the Value Added Tax Act 1994, by HM Revenue and Customs.
VAT is levied on most products and services rendered in the United Kingdom by registered firms and on some goods and services imported from outside the United Kingdom. VAT is an indirect tax because the seller (the company) pays the tax to the government rather than the individual who bears the tax’s economic burden.
How Value Added Tax Works
VAT is imposed on almost all goods and services in the UK. VAT registered businesses indirectly act as tax collectors for the government. They charge tax on the products and services they sell to the consumers. Companies do not collect this tax without any reward. Companies that are registered under VAT save a lot of money. Most of the companies hire VAT return services to pay their tax. It is a circle of paying and collecting tax. Sellers charge this tax to their consumers and pay the same tax while making any transaction. Companies do not transfer this tax to HMRC every time they make a transaction, but they file a tax return quarterly or yearly of the total tax amount they collected.
Input and Output Tax
Input tax and output taxes are other names of VAT charged and the VAT collected. The input tax applies to the VAT for business machinery, supplies, or expenses charged by your company to its suppliers. This requires the procurement of professional services, such as consulting fees or accounting services, as well as company telephone calls or re-selling products you buy. Output tax is the tax that you impose on the goods and services provided by your company. You charge the tax for production and collect it from your clients.
Your input tax will then have to be assessed against your production tax: whether or not you have to pay HMRC cash depends on how much VAT you have charged and how much you have paid. For example, you can charge VAT for all your customers but pay VAT for all the items you buy from your suppliers. In most cases, you will owe HMRC the excess VAT money if you receive more VAT from your customers than you payout to suppliers and service providers. You will fill in a form to refund the money from HMRC if you shell out more in input tax than you raise in production tax.
Calculation of VAT
We all know that we’re paying for VAT, but we do not bother about how it is calculated. To understand the calculation of VAT, there are two ways.
- VAT estimation on a net profit
- VAT extraction from a gross profit
These are fundamentally different equations, but we mix them up regularly, so before we look at how to measure them, we’ll talk about what they mean.
Gross Profit Vs. Net Profit
Gross profit refers to the whole of something, while net, after some deduction, refers to a part of a whole. Net income for a corporation, for example, is the income generated after all expenditures, overheads, taxes, and interests.Net profit is also called revenue of the business.
According to the definition, Gross profit is the cost of goods sold, and net profit is the final revenue after deducting all the interests and taxes from the net profit. So by keeping this in mind, if we study VAT, we do the exact opposite, from a practical perspective. As a percentage of the net profit, we calculate the VAT and then add it to the net sum to meet the gross.
The outcome is the same since the net profit is the sum without the VAT, but as we had to add the VAT during the calculations, it made the starting point different. So, it’s better to think of the net as the sum before the VAT has been applied in terms of VAT calculations. When we think about calculating VAT in this way, it’s normally when sales invoices are prepared. They include:
- The net selling value, the sum that belongs to the company
- VAT, which is part of the HMRC,
- The gross sum or complete invoice to be paid by the client
So, VAT is usually considered an unwanted tax, but all businesses have to pay this on their net figures. At 101Accountant provide accounting services, including VAT registration services, filing of VAT returns, and other services such as bookkeeping, payroll, and taxation.