What’s the difference between costs that are zero-rated, exempt and out of scope for VAT?

This article explains the difference between recording costs as zero-rated, exempt and out of scope for VAT in FreeAgent.

When you record a cost as zero-rated, exempt or out of scope for VAT, there’s £nil or no VAT to reclaim on the cost. However, the way they’re recorded on your VAT return is different.

If you’re not sure which option to choose for one of your costs, please speak to your accountant or check the guidance from HMRC.

Zero-rated

Costs that are zero-rated for VAT do have VAT on them, but at 0%. Examples include:

• books and newspapers
• most travel costs, such as train or air fares

Zero-rated costs have no effect on your VAT reclaim as there is £nil VAT to be recorded in box 4 on your VAT return. The total amount of the cost will appear in box 7.

Exempt

Costs that are exempt for VAT don’t have VAT on them. Examples include:

• all services provided by a post office, such as postage and stamps
• insurance and other financial services
• bank charges
• certain medical services

Exempt costs have no effect on your VAT reclaim as there is no VAT to be recorded in box 4 on your VAT return. The total amount of the cost will appear in box 7.

Legal differences between zero-rated and exempt

If you’re adding up your sales to see whether you need to register for VAT, you should include sales that would be zero-rated for VAT but exclude those that are exempt.

If you’re looking at which costs you can reclaim VAT on, you can include those that relate to making zero-rated sales, but exclude those that relate to making exempt sales.

If your business is using the VAT Flat Rate Scheme, you would include both zero-rated and exempt sales as part of your flat rate turnover.

Out of scope

Costs that are out of scope for VAT are outside the remit of the UK VAT system, which means that VAT doesn’t apply to them. Examples include:

• government-imposed tolls, such as MOT certificates, council tax and business rates
• staff wages and pensions
• taxes

Out of scope costs don’t appear anywhere on your VAT return as there is nothing to reclaim. Therefore, they don’t affect the figure in box 4 and the total cost isn’t included in the figure in box 7.

However, there is an exception for costs relating to services bought from overseas but enjoyed in the UK. Typically, if you buy a service overseas and enjoy it there, that would also be out of scope for UK VAT and not included on your UK VAT return.

If your business is using the VAT Flat Rate Scheme, sales that are outside the scope of VAT do not form part of your flat rate turnover.