Input Recovery – Zero-rated supplies

[Tax Student]

Hello, 

I am a law student studying VAT, I fear my understanding of the basics is preventing me from grasping further topics.

What I think I know…

Standard rated – charge output tax at 20% and recover input tax at 20%.

Zero rated – charge output tax at 0% and recover input tax at 20 or 5%???

Exempt – charge no output tax and recover no input tax.

To give a scenario…

I am a trader in magazines (zero-rated) , I buy the magazines from a producer and sell them on. I add no value, I’m simply a re-seller.

I charge output tax at 0% to my customers, but am I allowed to recover input tax at 20% on the magazines I have bought despite the item being zero-rated?

I buy a magazine for £20. 

I recover £2 input tax. 

I sell the magazine for £30. 

I charge no output tax. 

My friend a qualified tax advisor tells me that because you have purchased the magazine at 0% VAT then there is no input tax you can recover unless you were either a producer of the magazine or added value to it when selling it.

How does your say typical cornershop or news agents work who buys and sells milk, magazines etc?

Any help is greatly appreciated.

[Trevor S]

VAT is a tax charged on the supply of goods and services. Any supply made falls into one of three categories:

• “non-business” – outside the scope of VAT,
• “exempt business” – exempt from VAT, or
• “taxable business” – subject to VAT, either at standard rate (20%), reduced rate (5%) or zero rate (0%)

The types of supplies covered by each of these (apart from standard rate) are defined by schedules 7A to 9 of the Value Added Tax Act 1994. So standard rate is the “default” if your supply doesn’t meet the criteria for any of the other categories/rates.

You are responsible for determining which category the supplies you make fall under, and charging your customers any VAT at the appropriate rate.

If you are making “taxable business” supplies (third category above), you are entitled to reclaim any VAT that you are charged on related purchases. But you can’t reclaim VAT that you haven’t been charged.

So in your magazine example, your sale of the magazine is zero rated, so you don’t declare VAT on your £30 income. Your magazine supplier won’t have charged you any VAT either, so you haven’t got any VAT to claim on your £20 purchase. You have “added value”, in that it was worth £20 when you bought it, and £30 when you sold it. In reality the £10 difference isn’t all profit. Your business is likely to have incurred some other costs/overheads – and if you’ve been charged VAT on those, you can reclaim it.

Same principle applies to shops. They’ll need to determine the correct VAT rate for each item they sell. Provided that they all fall within the taxable business category, they can reclaim all of the VAT that they’ve been charged by their supplies – on the items being sold and any other running costs of the shop.

[Author]

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