The types of VAT a UK startup actually meets (and how to record each one)

The question that actually slows you down

Most VAT guides answer "what is VAT" and "do I need to register". Useful once. But once you're registered, that isn't the question you face any more. The question you face is smaller, sharper, and arrives forty times a week:

What VAT treatment does this transaction have?

An AWS invoice. A train ticket. A client lunch. A Companies House filing fee. Insurance. A contractor in Lisbon. Each one has a different answer, and picking the wrong one quietly misstates your return — usually in your favour, which is the direction HMRC notices.

This is a guide to the types of VAT in the UK as you actually meet them in the books: what each one does to your return, and how to record it without guessing. If you're earlier than that, start with what VAT is and whether you have to charge it and when you have to register.

The two-sided machine

Everything below only makes sense against one idea. VAT has two sides:

• Output VAT — what you charge customers and owe HMRC.
• Input VAT — what suppliers charged you and you reclaim.

You pay HMRC the difference. Get a treatment wrong on the input side and you reclaim VAT you weren't entitled to. Get it wrong on the output side and you under-declare what you owe. Both are corrections; one of them is a penalty.

The seven VAT treatments you'll actually meet

There are three rates. There are seven treatments, because "no VAT on this invoice" happens for several different reasons and your return needs to know which one.

1. Standard rate — 20%

The default. Most goods and services: software, hardware, professional fees, marketing, office supplies, most of what a startup buys. If you're unsure and the supplier is UK VAT-registered, standard is the likely answer — but "likely" isn't a method, which is rather the point of the rest of this list.

2. Reduced rate — 5%

A narrow set: domestic energy, children's car seats, some renovation work, certain mobility aids. Most software startups will go a whole year without meeting it. Take an office with a domestic-rate energy supply and you'll meet it there.

3. Zero-rated — 0%

A taxable supply, charged at nothing. Most food, children's clothes, books, newspapers, public transport, new residential construction. The train ticket to a client meeting is zero-rated — not exempt, and not "no VAT".

That distinction catches people out often enough to deserve its own section.

4. Exempt

No VAT, but for a different reason: the supply sits outside the VAT system entirely. Insurance, most financial services, postage stamps, some education and healthcare.

Zero-rated vs exempt looks like a distinction without a difference — both show £0.00 of VAT — but they behave differently in two ways that matter:

• The threshold. Zero-rated sales are taxable turnover and count towards the £90,000 registration threshold. Exempt sales don't. A business selling only zero-rated goods can be obliged to register while never charging a penny of VAT — and will usually want to, because it reclaims input VAT and files repayment returns.
• Recovery. If you make exempt supplies, you can't automatically reclaim all your input VAT. You land in partial exemption, where input VAT is apportioned between your taxable and exempt activities. Most startups never touch this. Fintechs, insurance brokers and some education businesses touch it immediately, and should involve an accountant before their first return rather than after.

5. Outside the scope

Not a supply for VAT purposes at all. Salaries. Dividends. Payments to HMRC. Most statutory fees, including Companies House filing fees. Transfers between your own bank accounts. Grants, usually.

These belong in your books but nowhere on your VAT return. Recording a Companies House fee as standard-rated and reclaiming 20% is a small error that repeats every year and is trivially spotted.

6. Reverse charge

The one that matters most to startups, and the one most often missed.

When you buy B2B services from an overseas supplier — cloud hosting, SaaS subscriptions, an overseas contractor, ad platforms billing from outside the UK — the supplier doesn't charge UK VAT. Instead you account for it: you declare the VAT as though you had charged it to yourself (output), and reclaim the same amount (input), in the same return.

If you recover VAT in full, it nets to nil in cash terms. So founders reasonably ask why it matters. It matters because both entries still have to appear on the return. Skip it and your Box 1 and Box 4 are both understated, and the figures HMRC compares against your accounts stop agreeing.

There is a second, unrelated reverse charge — the domestic reverse charge for construction services under CIS, where a UK subcontractor doesn't charge VAT to a UK contractor. If you're in construction, that's covered separately.

For a typical seed-stage startup, the reverse charge applies to a surprising share of the cost base. AWS, Google Cloud, Figma, Slack, an agency in Berlin — none of them charge you UK VAT, and all of them belong on your return.

7. No VAT

Not a tax treatment at all. A fact about the supplier: they aren't VAT-registered, so there was no VAT to charge. The sole trader designer who invoices you £800 with no VAT line is "no VAT" — not zero-rated, not exempt.

Worth keeping separate because it tells you something true: this cost carries no recoverable VAT and never will. And if that supplier later registers, the treatment changes.

Quick reference: what a startup actually buys

The same handful of purchases come up in every seed-stage set of books. Here's where they land:

Two rows in that table are the ones worth memorising, because they're where the money and the errors are: reverse charge, which covers most of a modern startup's tooling spend, and blocked entertainment, which looks recoverable on every receipt and never is.

The three that quietly cost startups money

Client entertainment is blocked. VAT on entertaining people you do business with is not recoverable, full stop, regardless of what the restaurant receipt shows. Staff entertainment is treated differently. This is one of the most common triggers in our guide to VAT return mistakes that attract an enquiry.

Cars are mostly blocked too. You can only reclaim VAT on buying a car if it's used exclusively for business and genuinely unavailable for private use — a bar most founders don't clear. Hiring is more forgiving: you can usually recover 50% of the VAT on a hire car, or all of it if the hire is for no more than ten days and strictly for business. Vans and commercial vehicles follow ordinary rules.

Pre-registration VAT is money people leave behind. You can reclaim VAT on goods you still hold going back four years, and on services going back six months, where they relate to your VAT-taxable business. A startup that bought laptops, monitors and a year of legal advice before crossing the threshold can often reclaim a meaningful sum on its very first return. Almost nobody does, because by then the receipts are in a drawer.

Which scheme you're on changes the answers

Standard accrual is the default: VAT is accounted for by invoice date, whether or not anyone has paid. It's what Ledgers runs, and what most VC-backed startups should be on.

Cash accounting (join with taxable turnover of £1.35 million or less) accounts for VAT when money actually moves. It helps cash flow if customers pay slowly, and hurts if you're usually in a repayment position.

The Flat Rate Scheme (join at £150,000 or less) looks attractive and is a trap for software businesses. You pay a fixed percentage of gross turnover and give up reclaiming input VAT. The catch is the limited cost business rule: if your spend on goods is less than 2% of turnover, or less than £1,000 a year, you must use a rate of 16.5%. A consultancy or software startup — whose costs are people and cloud, not goods — is almost always a limited cost business. At 16.5% of gross you frequently pay more than you would under standard VAT, while also losing recovery on everything you buy.

Run the arithmetic before joining, not after.

How Ledgers handles VAT

VAT in Ledgers isn't a box you fill in at quarter-end. It's derived per journal line, at the moment a transaction is categorised — including lines that come straight off the bank feed. Your VAT position is a consequence of your bookkeeping rather than a separate exercise laid on top of it, which is why the return traces back to individual transactions instead of being reconstructed from a spreadsheet.

Three things do the work:

Your chart of accounts carries a default. Each account has an expected VAT treatment, so choosing the category proposes the treatment. Pick "Insurance" and it knows exempt. Pick "Travel" and it knows zero-rated.

The categorisation agent proposes a treatment with a confidence score, based on the supplier, the description, the amount, and what you've decided about similar transactions before. A review agent then checks that proposal against six tests, one of which is specifically the VAT treatment.

The filed number is deterministic. The advisory agent can flag a treatment it doubts, but it never computes what you file. The VAT return is produced by the ledger, and every box drills down to the journal lines behind it.

Recording a VAT expense in the categorisation queue

Here's the loop in practice.

1. The transaction arrives. Your bank feed imports it and the agents categorise it before you ever see it. Most arrive already proposed with an account, a VAT treatment and a written rationale.

2. Open the review queue. Each card shows the proposal, the confidence behind it, and — where the review agent had a concern — a named chip saying exactly what it doubted.

3. Check the VAT treatment. Every card carries a VAT picker holding an explicit treatment: Standard, Reduced, Zero, Exempt, Reverse charge, Outside scope, No VAT. It's seeded from the agent's proposal and never left blank. Change it if the agent got it wrong.

4. Approve. When the review agent has raised exactly one concern, the button names it — if the concern was VAT, it reads "VAT is fine". You're signing a specific claim rather than clicking a generic approve, and that claim is recorded as evidence.

5. It becomes a rule. Approve the same supplier and treatment a few times and Ledgers learns the pattern. The next AWS invoice arrives already marked reverse charge, and stops asking.

The practical advice worth taking from all this: don't fix VAT at quarter-end. Fix it at the card. A treatment corrected once, in the queue, becomes a rule that is right for every future transaction from that supplier. A treatment corrected in a spreadsheet in the last week of the quarter is right once and wrong again next month.

What quarter-end should look like

If the treatments are right transaction by transaction, the return is already computed. Ledgers files it under Making Tax Digital directly to HMRC, and every box traces back to the journal lines that produced it — so when HMRC asks why Box 4 is what it is, the answer is a list of transactions, not a reconstruction.

That is the whole argument for getting the treatment right at the point of categorisation rather than the point of filing. VAT stops being a quarterly event you brace for, and becomes a property of books that were correct all along.

Next: how to do a VAT return for the first time →

Frequently asked questions

What are the different types of VAT in the UK?

There are three VAT rates — standard (20%), reduced (5%) and zero (0%) — but in bookkeeping you'll meet seven treatments: standard, reduced, zero-rated, exempt, outside the scope, reverse charge, and no VAT. The last one isn't a tax position at all; it means the supplier didn't charge VAT because they aren't registered.

What's the difference between zero-rated and exempt VAT?

Both mean no VAT is added to the price, but they behave differently on your return. Zero-rated sales are taxable supplies at 0%, so they count towards the £90,000 registration threshold and you keep full recovery of VAT on your costs. Exempt sales sit outside the VAT system, don't count towards the threshold, and can restrict how much input VAT you reclaim under the partial exemption rules.

Do I charge VAT on services bought from overseas suppliers?

For most B2B services bought from outside the UK — cloud hosting, software subscriptions, overseas contractors — you apply the reverse charge. You declare the VAT as if you had charged it to yourself, and reclaim the same amount in the same return. If you can recover VAT in full it nets to nil in cash terms, but both entries still have to appear on the return.

Can I reclaim VAT on purchases made before I registered?

Yes, within limits. You can reclaim VAT on goods you still hold going back four years, and on services going back six months, provided they relate to your VAT-taxable business. For a startup that bought laptops and equipment before crossing the threshold, this is often a meaningful refund on the very first return.

Can I reclaim VAT on client entertainment?

No. VAT on entertaining people you do business with is blocked, whatever the receipt says. Staff entertainment is treated differently. Recording a client lunch as standard-rated and reclaiming the VAT is one of the most common errors HMRC picks up.

See your numbers without learning accounting

Ledgers does the bookkeeping — bank feeds, VAT, year-end — and keeps your accountant in the loop. Free for pre-revenue founders.

Start free →

Get the next guide by email

Plain-English accounting for founders — a couple of new guides a week. No spam, unsubscribe anytime.

Subscribe

Keep reading · VAT

“What is…” basics

What is VAT and do I actually have to charge it?

VAT explained in plain English: what it is, the £90,000 registration threshold, the standard, reduced and zero rates, and input vs output VAT — without the jargon.

6 min read“Do I even need to…”

When do I have to register for VAT?

You must register for VAT once your taxable turnover passes £90,000 in any rolling 12 months. Here's the threshold in plain English, plus voluntary registration and what happens if you register late.

6 min readVAT

How to do a VAT return for the first time

Filing your first VAT return? Here's exactly what to expect, what counts, a box-by-box walkthrough, and the first-return quirks like pre-registration VAT — plus how Ledgers builds the whole thing for you.

6 min read