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Not All “Zero” Means the Same in VAT
When it comes to VAT, not charging customers any tax doesn’t always mean your business gets off easy—or can recover costs behind the scenes. The UK VAT system distinguishes between two important types of non-standard-rated supplies: zero-rated and exempt. Although both result in no VAT being added to a customer’s bill, they are very different in terms of VAT recovery and business impact.
If your business handles goods or services that fall into either category, knowing the difference can make or break your VAT planning. Here’s what every business should understand.
What Are Zero-Rated Supplies?
Zero-rated supplies are still considered taxable under VAT rules, but the VAT rate charged is 0%. This distinction is crucial. Because they are taxable (even at 0%), businesses selling zero-rated goods and services can:
- Register for VAT, and
- Reclaim the VAT they pay on purchases and operating costs related to those supplies.
Examples of Zero-Rated Supplies
- Most basic food items
- Children’s Clothing
- New residential property sales
- Books and newspapers (including digital versions)
- Passenger transport by bus, train, plane, or ship
- Some exports and supplies to charities
Even though you don’t charge VAT to customers, your business still benefits from being within the VAT system.
What Are Exempt Supplies?
Exempt supplies are completely outside the scope of VAT. This means if your business only makes exempt supplies, you:
- Cannot charge VAT to customers
- Cannot register for VAT (unless you also make taxable supplies)
- Cannot reclaim any of the VAT on related costs
Examples of Exempt Supplies
- Most land and property transactions
- Residential property lettings
- Insurance services
- Financial services (like arranging loans)
- Education and some health services
- Betting and gaming
In essence, exempt means you’re shut out of the VAT recovery system. You’re collecting no VAT—but you’re also stuck with the VAT you pay on related expenses.
What Happens if You Make Both?
Many businesses carry out a mix of activities—some taxable (including zero-rated) and some exempt. These businesses are considered partially exempt. They can register for VAT but can’t recover all their input VAT. Instead, they have to calculate what proportion of their input VAT relates to taxable supplies and what relates to exempt ones.
This requires:
- A partial exemption calculation
- Periodic reviews to ensure accuracy
- Possibly having to repay some of the VAT reclaimed earlier
It adds complexity and requires good bookkeeping.
The De Minimis Rule: A Helpful Shortcut
If the total amount of VAT relating to exempt supplies is relatively small, you may still be allowed to reclaim all your input VAT. This is known as the de minimis limit, and to qualify:
- Exempt input VAT must be less than £625 per month on average (or £7,500 per year), and
- It must also be no more than 50% of your total input VAT.
If both conditions are met, the exempt input VAT becomes fully recoverable, and your business avoids the need for partial exemption calculations.
Why the Difference Matters: Real-World Examples
Example 1: A Property Developer’s Surprise : A company builds new zero-rated homes, so it reclaims all VAT on materials and services. But if it can’t sell the homes due to a market slowdown and decides to rent them out instead (an exempt activity), it may need to repay much of that VAT. A costly decision is made without considering the VAT implications.
Example 2: A Growing Accountancy Firm: An accountancy practice providing standard VAT-rated services begins by offering financial advice and earning commissions. That new income is exempt, so now a chunk of their overhead costs becomes linked to exempt supplies—meaning they can’t recover as much VAT as before.
In both examples, the businesses went from full VAT recovery to partial or no recovery—often without realising it until it was too late.
Planning Ahead: What Businesses Should Do
If your business is considering branching into exempt activities, don’t go in blind. You’ll need to:
- Understand how it affects your VAT position
- Anticipate any irrecoverable VAT on costs
- Adjust pricing or budgeting to account for lost VAT recovery
- Keep detailed records to support partial exemption calculations
Ignoring these implications could eat into your profits—or worse, land you with an unexpected VAT bill.
Zero-rated and exempt might sound similar, but in VAT terms, they’re worlds apart. One keeps you inside the VAT system, offering valuable input tax recovery. The other locks you out. Knowing the difference and planning accordingly is essential to avoid surprises and keep your business financially efficient.
Need Help Navigating VAT Classifications?
At Tax Accountant, we help UK businesses get VAT right—from registration to reclaiming costs and staying compliant. If your business deals with zero-rated, exempt, or mixed supplies, we’ll make sure you understand the rules and get the best outcome. Book a consultation today and stay one step ahead of VAT.