What are VAT codes?

What are VAT codes?

VAT codes can be confusing and making VAT mistakes worries almost one-fifth of small business owners.

According to a study, 18% worry about making mistakes, while 19% fear they’ve missed something on their VAT return.

VAT, or Value Added Tax, is something that can be a confusing part of business finances. This is especially so when dealing with expenses and sundry costs of running your company.

Many business owners are also left wondering what VAT codes to use when using their accounting software. Getting the codes right from the start will reduce any issues in the future.

Here is our explanation of the VAT codes in Xero (our preferred accounting software supplier) as well as a quick introduction to them.

What are VAT codes?

HMRC uses the codes to identify what VAT needs paying on different goods and service. Usually, they are composed of a percentage and up to two letters. They may appear differently depending on whether it is used on sales or purchases forms.

If your business is VAT registered, you should charge output tax on taxable services and goods you sell. You then collect the tax from customers or clients and pay it to the government at set intervals throughout the year.

At times when you are the customer, you may be charged VAT on taxable services and goods that you buy for your business. You can reclaim any tax paid on your VAT return if the amount paid in input tax is more than what you were charged as output tax. If it’s the other way around, you pay HMRC the difference.

The standard VAT rate is 20% but it sometimes varies depending on the goods and services sold by your business. And this is where different codes are used.

For example, selling children’s clothes and most food attracts a 0% rate of VAT. Meanwhile, home energy means you are eligible to pay VAT at 5%.

Xero and VAT Codes

Xero has the ability to complete your VAT return and submit it to HMRC. These returns use the detail from the transactions in Xero to calculate the VAT return box amounts.

Xero uses the VAT tax rate selected for each line in your transactions to work out the tax for that line. Sometime multiple rated supplies can be on a bill. It is important you take care when entered the codes so Xero can calculate the correct VAT amount.

Businesses using the VAT flat rate scheme or those with import/exports to the EU can access additional tax rates.

The table below explains the main tax rates in Xero.

Xero NameDescriptionExamples
20% (VAT on expenses/income)20% standard rate on most goods/servicesPrinting, office supplies, maintenance services
5% (VAT on expenses/income)5% reduced VAT rateEnergy supplies, children’s car seats
Zero Rated Expenses0% VAT rate but still eligible for VATChildren’s clothes, printed books, newspapers
No VATSupplies outside the scope of VAT.Goods from none VAT registered companies. Wage payments.
Exempt Expense/incomeGoods/services exempt from VATPostage stamps, financial and property transactions
Reverse charge expenses (20%)20% reverse charged on income and expenseSome software supplies based outside UK.
Main tax rates in Xero

What is the difference between Zero rated and Exempt?

Exempt and Zero rated goods are similar as they both do not charge VAT on goods or services sold. The main difference between the two tax codes is to do with the services your own business supplies.

If you sell zero rated goods you can reclaim VAT on any purchases directly related to those sales. If you sell exempt goods generally you can not claim back any VAT on purchases.

Reverse Charge Expenses

This VAT code should be used when you have bought services from a provider outside the UK, for example Microsoft Ireland. It means you act as both supplier and customer. You charge yourself VAT and then claim it back with the 2 amounts cancelling each other out. They will show separately on your VAT return.

This code should not be used for the domestic VAT reverse charge scheme for building and construction services. More information on that scheme can be found here.

If you struggle with VAT codes or would like to hear more about the VAT services we can provide, contact us today.