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Choosing between VAT Rates in Xero

Tax rates in Xero can be pretty confusing. In a typical Xero account you will be faced with a number of different options. In this post we aim to explain the circumstances for using each.

Remember that if you are not VAT registered you should always use ‘No VAT’ and can ignore the rest of this post. Also note that this information is relevant to UK businesses only.

Here are the options that Xero throws at you:

The income options:

The expense options:

If you have an older Xero account you may find you have different names for these. Ask your accountant if you aren’t sure which one relates to which.


Tax rates for sales

A general comment on sales rates

If you sell a product or service it is your responsibility to understand the VAT rate of that product or service. If you are unsure please ask your accountant for help as mistakes can end up being extremely costly.

Certain areas can be extremely complicated, we urge particular caution if you are selling food, clothes, medical items or are dealing extensively with the public sector.

In this post we link extensively to this Gov UK article listing out common VAT rates.


20% (VAT on Income)

This is the standard sales tax rate for a sale to a VAT registered business. You should use this when you are VAT registered and selling goods or services to business or consumers in the UK or selling to consumers (not businesses – see Zero Rated EC Goods below) in the EU.

There are exceptions to the 20% rate, you can see a big list here. If that list doesn’t include what you are selling then you should charge 20%.


5% (VAT on Income)

We wouldn’t expect to see this used. Certain goods or services can be sold at a 5% VAT rate. The items are listed here and are primarily ‘public goods’ like energy and medical products.

So you should only use this tax rate in Xero when you are selling a product or service that is specifically listed as having a 5% VAT rate, to customers (business or individuals) in the UK or individuals in the EU.


Zero Rated Income

In addition to the 5% rate, certain products and services charge VAT at a 0% rate. Again they are listed here as 0%.

There are a few circumstances that we would expect to see small businesses able to use this rate, normally when selling certain services to charity or certain items like books, unprepared food (e.g. fruit) or children’s clothing.


Exempt Income

Exempt income is very similar to Zero rated but with the exception that businesses that sell exempt goods and services are not allowed to claim back any VAT (and in most cases will never register for VAT).

Again the Gov UK listing of VAT rates is useful here in order to identify products and services that count as Exempt Income.


Zero Rated EC Goods Income

This tax rate should be picked when you are selling goods (i.e. physical things) to a VAT registered business based in the EU.

The tax rate results in no VAT being added to the sale and is appropriate for sales that fall into the EU Reverse Charge system.

When you use this tax rate it will mean you also have to complete an EC Sales List so before using it you must collect your customers VAT number.


Zero Rated EC Services

This is the services version of the Zero Rated EC Goods Income. It should only be used when selling services (i.e. not physical things) to VAT registered businesses in the EU.


Tax rates for sales

A general comment on expense rates

Unlike sales you shouldn’t have to spend too long researching the rates of what you buy. In fact you can focus entirely on the invoice you have been provided by the vendor.

If you buy a VAT inclusive good or service the vendor must provide you with an invoice or receipt showing that VAT has been charged. You must follow this invoice or the VAT claimed back from HMRC will be invalid.

Some till receipts are pretty confusing. If there is a VAT number on the receipt then it is assumed VAT is included in the purchase, unless there is a little letter or other indicator next to the line item that indicates the item does not VAT included. Unfortunately the indicators are not universal, Tesco receipts put an asterisk on them and Morrissons put an ‘F’ where the line doesn’t include VAT for just two examples.

Bear in mind though that you can only claim back UK VAT. So if you have an invoice from a company in Ireland or Luxembourg with VAT on it you should pick NO VAT. You might also want to investigate if they can re-issue the invoice without VAT under the reverse charge system.


20% (VAT on Expenses)

Use this rate when you have an invoice that indicates 20% VAT has been deducted. This will be the case for the majority of UK purchases but by no means guaranteed. Note that if you have a till receipt then it can be a bit harder to identify (see general comment above).


5% (VAT on Expenses)

Use this rate when you have an invoice that indicates 5% VAT has been deducted. You will normally see a 5% rate on gas and electricity bills.


Zero Rated Expenses

Use this rate when you have an invoice for a purchase that has 0% VAT on it.

It can often by very difficult to identify the difference between Zero Rated and Exempt Expenses. We would urge you not to worry too much as using any of these items will result in the same VAT claim (i.e. none) so no tax will be claimed incorrectly if the wrong one is used.

If you are unsure whether you are looking at a zero rated or exempt expense you can check to see if the product or service purchased is included in HMRCs listing here.


Exempt Expenses

Use this rate when you have an invoice for a purchase that is Exempt from VAT. You will commonly see these for items like bank fees and insurance.

It can often by very difficult to identify the difference between Zero Rated and Exempt Expenses. We would urge you not to worry too much as using any of these items will result in the same VAT claim (i.e. none) so no tax will be claimed incorrectly if the wrong one is used.

If you are unsure whether you are looking at a zero rated or exempt expense you can check to see if the product or service purchased is included in HMRCs listing here.


No VAT

Use this rate when you have a receipt that either has no VAT number on it.

That means you will be using this code for all purchases you make outside of the EU plus some purchases from tiny businesses that aren’t VAT registered.


VAT on Imports

If you import goods from overseas you may have to pay VAT on the items when they clear through customs. In this situation you will likely end up with an invoice from your supplier for the original cost of the item and then an invoice from your courier that is made up purely of VAT (though maybe some additional lines for services).

You should use the VAT on Imports rate for these pure VAT invoices / invoice line. Here the amount reclaimable is not merely 20% of the amount paid but 100% of the amount so it needs it’s own special treatment in Xero.


EC Acquisitions (20%)

Use this when you buy physical goods (use Reverse Charge Expenses 20% for Services) from the EU under the reverse charge system. This is the system whereby if you are buying goods or services from EU businesses and provide them with your VAT number, then they don’t need to charge VAT.

Instead you report the VAT on your return, which Xero will do for you if you use this tax rate. It will do this by adding 20% of the purchase to Box 2 of your return and an equal and opposite amount to Box 4. So the net position is that the two amounts will cancel each other out and not increase your VAT liability (or refund).


Reverse Charge Expenses (20%)

Use this when you buy services from the EU under the reverse charge system. This is the system whereby if you are buying goods or services from EU businesses and provide them with your VAT number, then they don’t need to charge VAT.

Like the EC Acquisitions option above, this will not change the amount of VAT owed at all.


EC Acquisitions (Zero Rated)

Use this in the very rare case that you have to report a Zero rated purchase of goods from an EU supplier under the reverse charge system.


Zero Rated EC Expenses

Use this in the very rare case that you have to report a Zero rated purchase of services from an EU supplier under the reverse charge system.


 

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