What are input and output VAT?

How do input and output VAT fit together?

The names are from the business's point of view: VAT on what goes out is output VAT, VAT on what comes in is input VAT. Every VAT return is the same sum: output VAT for the period, less input VAT for the period, equals what you pay or reclaim.

Output VAT is never your money. You collect it on HMRC's behalf and hold it until the return is due, which is why a healthy-looking bank balance in a VAT-registered business is partly an illusion. Input VAT, meanwhile, is money you have paid out and are entitled to get back, provided the purchase was for the business and you hold a VAT invoice for it.

Not everything carries VAT at the standard rate of 20%. Some goods and services are reduced-rated, zero-rated or exempt, and some costs, such as client entertaining and most cars, carry VAT you cannot reclaim. The bookkeeping job is recording the right rate on each transaction so the two totals are correct at quarter end.

A worked example

In a quarter a plumber invoices £24,000 of work plus £4,800 output VAT. In the same quarter he buys £9,000 of materials, fuel and tools carrying £1,800 of input VAT, and pays £150 for a customer's lunch, whose VAT he cannot reclaim.

His VAT return shows output VAT £4,800, input VAT £1,800, and £3,000 due to HMRC one month and seven days after the quarter ends. The lunch is left out of the input figure.

The following quarter he buys a £24,000 van with £4,800 of VAT on it and has a quiet spell with only £12,000 of sales. Output VAT £2,400, input VAT £4,800 plus £600 on other costs, and HMRC owes him £3,000. He files early, because a repayment return is the only kind worth hurrying.

What do people get wrong?

• —Reclaiming input VAT without a VAT invoice. A card receipt showing a total is not enough; the invoice has to show the VAT.
• —Reclaiming VAT on things that are blocked, such as entertaining clients or a car with any private use.
• —Treating output VAT as income. It belongs to HMRC from the moment it is charged, and spending it is borrowing from a lender with no patience.
• —Missing input VAT on small purchases because the receipt was never recorded. Each one is small; a year of them is not.