Prices can be confusing when they involve VAT. You may see quotes that state “net of VAT” or figures that already include VAT. By not understanding the difference between these two, you may make decisions that cost you more than expected.
What Net of VAT Actually Means
When a listed price is “net of VAT”, it is showing the amount before any added VAT. In other words, it is the cost of a product or service without tax.
Here is a simple example:
- Net Price = £500
- VAT (20%) = £100
- Gross Price = £600
If you receive a quote of £500 net of VAT, the total you will pay (assuming VAT applies), is £600.
This distinction is important when comparing quotes. One supplier may provide prices net of VAT, while another shows VAT-inclusive figures. If you do not notice the difference, you may think one option is cheaper when in reality it is not.
Explaining VAT
VAT, or Value Added Tax, is a consumption tax that applies to most goods and services in the UK. Businesses collect VAT on behalf of HMRC. Although businesses add VAT to their sales, they can usually reclaim the VAT they pay on their own purchases.
The standard VAT rate is 20%. Some products are chargeable at 5% and some are zero-rate. While others, such as financial services and education, are completely exempt.
Here is how the process works:
- A VAT-registered business adds VAT to its selling price
- It passes the collected VAT to HMRC, minus any reclaimed VAT on expenses
- VAT-registered businesses do not bear the cost of VAT in the long run
- Non-registered traders cannot reclaim VAT, so it becomes a real cost for them
Net Price vs Gross Price
It is easy to confuse net and gross prices.
- Net Price is the value before VAT applies
- Gross Price is the full amount including VAT
For businesses, especially those dealing with other VAT-registered organisations, the net price is often more important. For consumers, the gross price is what matters because it represents the actual moment paid.
How to Calculate Net of VAT
Working out net and gross amounts is straightforward once you know the method.
If you have the net price, multiply it by the VAT rate and then add it to the net figure. This gives the gross prices. For example:
- Net Price = £100
- VAT (20%) = £20
- Gross Price = £120
If you already have a VAT-inclusive (gross) figure, divide it by 1 plus the VAT rate. At a 20% rate, divide by 1.20. For example:
- Gross Price = £120
- £120 / 1.20 = £100 (Net Price)
Why Net of VAT Matters for Sole Traders
If you have registered for VAT, you must charge VAT once your turnover exceeds £90,000. You can reclaim VAT on most business expenses. For you, VAT is a tax that flows through your accounts, rather than a direct cost.
If you have not registered for VAT, you cannot add VAT to your sales. You also cannot reclaim VAT on purchases. That means any price listed as net of VAT becomes your total cost.
For example: A VAT-registered business can reclaim VAT on new equipment, but a non-registered sole trader must pay the full amount.
VAT Registration and Schemes
If your taxable turnover passes the £90,000 threshold, registration is compulsory. Some businesses, however, choose to register voluntarily. Voluntary registration makes sense if most of your clients have registered for VAT too or if you spend heavily on items that include VAT.
There are also schemes which simplify VAT:
- The Flat Rate Scheme allows you to pay a fixed percentage of your gross turnover
- The Cash Accounting Scheme allows you to only pay VAT when customers pay you rather than when you issue invoices
Reporting VAT
Once registered, you must report VAT by filing VAT returns. You should usually submit returns every three months. The deadline is one month and seven days after the accounting period ends.
Your return shows the VAT collected from customers and the VAT paid on business purchases. The balance between these two amounts is what you either pay to or reclaim from HMRC.
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This article is for general informational purposes only and does not constitute legal or financial advice. While we aim to keep our content up to date and accurate, UK tax laws and regulations are subject to change. Please speak to an accountant or tax professional for advice tailored to your individual circumstances. Pi Accountancy accepts no responsibility for any issues arising from reliance on the information provided.