VAT payable is the difference between the VAT you charge your customers (output tax) and the VAT you pay on business purchases (input tax). The core formula is simple: Output VAT minus Input VAT equals VAT payable. If the result is negative, you’re owed a refund. The real work lies in tracking every transaction correctly and knowing which adjustments apply.
The Core Formula
Every VAT-registered business collects VAT when it sells goods or services and pays VAT when it buys supplies. At the end of each reporting period, you calculate the net amount:
- Output VAT (collected): The total VAT you charged on all your sales during the period.
- Input VAT (deductible): The total VAT you were charged on business purchases, raw materials, and operating expenses during the same period.
Subtract input VAT from output VAT. If output VAT is larger, you owe the difference to the tax authority. If input VAT is larger (common when a business makes large purchases or investments), the tax authority owes you a refund.
A Step-by-Step Example
Suppose your business sells consulting services and your country’s standard VAT rate is 20%. During the quarter, you invoiced clients a total of £50,000 in net fees. You added 20% VAT on each invoice, so your output VAT is £10,000.
During the same quarter, you spent £12,000 (before VAT) on office rent, software subscriptions, and other business costs. Your suppliers charged you 20% VAT on those purchases, so your input VAT is £2,400.
Your VAT payable for the quarter: £10,000 minus £2,400 equals £7,600. That’s the amount you remit to the tax authority.
When You Sell at Different Rates
Many countries apply reduced or zero rates to certain goods like food, children’s clothing, or books. If you sell items at multiple VAT rates, calculate the output VAT for each rate separately, then add them together before subtracting your total input VAT. For instance, if you sold £20,000 of standard-rated goods at 20% (£4,000 output VAT) and £10,000 of reduced-rate goods at 5% (£500 output VAT), your total output VAT is £4,500.
Extracting VAT From a VAT-Inclusive Price
Sometimes you need to work backwards from a price that already includes VAT. To find the VAT portion of a VAT-inclusive amount, use the VAT fraction. For a 20% VAT rate, the fraction is 20/120 (or 1/6). Multiply the inclusive price by this fraction to isolate the VAT.
Example: a receipt shows £360 including VAT at 20%. The VAT portion is £360 × (20/120) = £60. The net price is £300. This is how you determine how much input VAT you can reclaim on purchases when your receipts show only the total.
For a 5% rate, the fraction is 5/105. For any rate, the pattern is: rate divided by (100 + rate).
How the Flat Rate Scheme Works
Some countries offer a simplified flat rate scheme for smaller businesses. Instead of tracking input and output VAT separately, you apply a single fixed percentage to your total VAT-inclusive turnover. The percentage depends on your industry.
Here’s an example from the UK scheme. You’re a photographer and you bill a client £1,000 plus 20% VAT, making the invoice total £1,200. The flat rate for photography is 11%. Your VAT payment is 11% of £1,200, which is £132. You keep the difference between the £200 of VAT you charged the client and the £132 you owe, meaning the scheme effectively gives you £68 toward your business costs.
The trade-off is that you cannot reclaim input VAT on individual purchases (with limited exceptions for capital assets above a certain threshold). The flat rate scheme works best for businesses with low costs relative to their revenue. If you spend heavily on VAT-bearing supplies, the standard method usually saves you more.
Cash Accounting vs. Invoice Accounting
The timing of your VAT calculation depends on which accounting method you use. Under the standard invoice (accrual) method, you account for VAT based on the date you issue or receive an invoice. Under cash accounting, you account for VAT only when money actually changes hands.
The total VAT payable over time is the same either way. The difference is cash flow. With cash accounting, you don’t owe VAT on a sale until your customer pays you. This protects you if clients are slow to pay. On the other hand, you can’t reclaim input VAT on a purchase until you’ve actually paid the supplier. Most countries restrict the cash accounting option to businesses below a certain turnover threshold.
Adjustments That Reduce Your VAT Bill
Credit Notes
If you overcharged a customer, made a billing error, or agreed to reduce the price after the sale, you issue a credit note. The credit note reduces your output VAT for the period in which you issue it. You cannot issue a credit note simply because a customer hasn’t paid you. There must be a genuine overcharge, mistake, or agreed price reduction.
Bad Debt Relief
When a customer never pays an invoice, you may have already remitted VAT on that sale. Bad debt relief lets you reclaim that VAT, but only after the debt has gone unpaid for at least six months past the later of the payment due date or the date of supply. To qualify, you must have already accounted for and paid the VAT to the tax authority, and you must write off the debt in your VAT records and move it to a separate bad debt account.
If you received partial payment, you can only claim relief on the VAT relating to the unpaid portion. Payments are attributed to the earliest supply first, unless the customer specifies otherwise. If you also owe money to the same debtor, you must offset what you owe them against the bad debt before calculating your relief. Claims generally must be made within four years and six months of the later of the payment due date or the supply date.
To claim, include the VAT amount in the input tax box of your VAT return for the period when you meet all the conditions.
Partial Exemption
If your business makes both taxable and VAT-exempt supplies (common in financial services, education, and healthcare), you can only reclaim input VAT on the portion of your costs that relate to taxable sales. This is called partial exemption. You’ll need to apportion your input VAT, typically based on the ratio of taxable turnover to total turnover, though some businesses use other methods approved by their tax authority.
For example, if 70% of your revenue comes from taxable supplies and 30% from exempt supplies, you can generally reclaim 70% of the input VAT on costs that serve both parts of the business. Costs that relate exclusively to taxable supplies are fully reclaimable, while costs tied only to exempt supplies are not reclaimable at all.
Keeping Accurate Records
Your VAT calculation is only as good as your records. For every transaction, you need a valid VAT invoice showing the supplier’s VAT registration number, the date, the net amount, the VAT rate, and the VAT charged. Many tax authorities now require digital record-keeping and electronic submission of VAT returns.
Set up your accounting software to categorize sales and purchases by VAT rate automatically. Reconcile your VAT account at the end of each period before filing. Small errors compound quickly, and discrepancies between your books and your VAT return can trigger penalties or audits. If you buy goods or services from abroad, check whether you need to self-account for VAT under the reverse charge mechanism, where you act as both supplier and buyer for VAT purposes, reporting the VAT as both output and input tax on the same return.