What does VAT exemption entail (and who is eligible for it)?

 A value-added tax (VAT) is a type of tax that is levied on taxable goods and services throughout the supply chain. Some items and services are considered non-taxable or VAT-exempt by the government. There are also certain things that are completely exempt from VAT.

Reduced or zero-rated items are not the same as exempt or out-of-scope items. Even if reduced rate items are charged less or no VAT, they are nonetheless deemed VAT taxable (VATable) and hence differ from the exemption.

You cannot become VAT registered if you just sell VAT exempt things, thus you are a VAT exempt firm. You are a partially exempt business if you sell certain exempt items but also some taxable items.

Because you don't sell any taxable things to your consumers, you won't be able to register for any VAT scheme. However, you may still need to purchase some taxable things to run your business, in which case you must pay VAT on those purchases and cannot claim VAT credit.

Businesses that are partially exempt, on the other hand, can register for VAT and reclaim VAT on some taxable purchases.

In this article, we'll untangle the web of what constitutes taxable and nontaxable goods and services, look at the differences between VAT exempt, out of scope, reduced, and zero rates, consider the advantages and disadvantages of being VAT exempt and explain how partially exempt businesses can register for VAT.

What is VAT and how does it work?

Before we get into the technicalities of VAT exemption, it's critical to understand the fundamentals of VAT. The 'value-added' to goods or services as they go through the supply chain (for example, from the manufacturer or supplier to the business (you) and finally to the client) is represented by VAT.

VAT is a consumption tax that applies to a wide range of physical and digital products and services. VAT-registered enterprises, in essence, collect VAT on behalf of the government and remit it to the government throughout the year. Your chosen VAT scheme and/or your individual industry rate will determine the exact payment date and amount.

VAT-registered enterprises are responsible for charging customers an output tax (equivalent to mailing an invoice) and paying suppliers an input tax (similar to paying an invoice).

If your company has paid more VAT to suppliers than it has charged to customers, you must claim the difference from HM Revenue and Customs (HMRC). If you've earned more VAT from customers than you've paid to businesses, you'll have to make up the difference with HMRC.

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