VAT
Value Added Tax is a consumption tax charged at each stage of the supply chain and collected by VAT-registered UK businesses on behalf of HMRC. Standard rate is 20%, with reduced and zero rates applying to specific goods and services.
Also: value added tax
VAT is collected from customers and offset against VAT paid to suppliers. The difference — output VAT minus input VAT — is paid to HMRC (or reclaimed if input exceeds output) via a VAT return, typically quarterly. Once a business’s taxable turnover exceeds the registration threshold (£90,000 in the 2024/25 tax year), registration is compulsory.
In Xero, every transaction carries a tax rate code — 20% (VAT on income), 20% (VAT on expenses), Zero Rated, or Exempt. Xero uses those codes to populate the VAT return automatically. Getting them right at the point of entry matters: a supplier invoice coded as Exempt when it should be 20% understates your input VAT claim and inflates the amount you remit to HMRC. A reconciliation error — a £6,000 payment posted without splitting the £1,000 VAT element — compounds into a filing discrepancy.
VAT and month-end
A clean bank reconciliation is a prerequisite for a reliable VAT return. If bank lines are unmatched, the VAT figures Xero surfaces on the VAT return tab may be incomplete. Under Making Tax Digital, VAT returns are submitted directly from Xero to HMRC. Reviewing the VAT audit report before filing is good practice: it lists every transaction in the return, making it easy to spot a miscoded rate or a missing bill.