What UK small businesses need to know about VAT in 2026

VAT in 2026: what has changed and why it matters

VAT rules in 2026 still follow the same core structure, yet several practical changes affect how small businesses register, charge VAT, and report figures. The most significant point for many firms remains the VAT registration threshold, which continues to shape pricing, cash flow, and admin time. Even when turnover stays below the threshold, voluntary registration can suit businesses that buy VATable goods or services and want to reclaim input VAT, although it can also make prices less competitive for customers who cannot reclaim VAT.

Digital reporting expectations also matter more in 2026. Many businesses now treat Making Tax Digital for VAT as standard practice rather than a one-off change. That shift has raised the bar for record keeping. Clear audit trails, consistent invoice data, and timely reconciliations reduce the risk of errors that can trigger queries or penalties. Businesses that still rely on manual rekeying often find that small mistakes compound across quarters.

HMRC has also continued to tighten its approach to compliance and late submission. The points-based penalty model means that repeated small slips can become costly, even when a business pays VAT on time. Checking filing dates, keeping evidence for VAT decisions, and correcting errors promptly can protect margins. Guidance and updates from HM Revenue & Customs (HMRC) remain the most reliable reference when a transaction sits in a grey area, such as mixed supplies, deposits, or cross-border services.

For small businesses, these changes matter because VAT affects day-to-day trading decisions. A well-managed VAT position supports cash flow, reduces admin disruption, and helps a business price with confidence.

VAT registration in the UK: thresholds, timing, and voluntary options

Most UK small businesses must register for VAT when taxable turnover exceeds the registration threshold in any rolling 12-month period, or when the business expects to exceed the threshold in the next 30 days alone. “Taxable turnover” includes standard-rated, reduced-rated, and zero-rated sales, but excludes VAT-exempt income. HMRC sets and updates the threshold, so check the current figure on the official GOV.UK VAT registration page before planning prices or contracts.

Timing matters. Once the threshold trigger occurs, the business must register within the required deadline and start charging VAT from the effective date of registration. Late registration can create an unexpected VAT bill, as HMRC may treat past sales as VAT-inclusive.

• Mandatory registration: required when turnover passes the threshold under the rolling test, or when the 30-day expectation test applies.
• Voluntary registration: available below the threshold, often useful when customers are VAT-registered or when input VAT on costs is high.
• Exception from registration: possible in limited cases where the threshold breach is temporary; HMRC must agree.

Voluntary registration can improve VAT recovery on business purchases, yet it can also affect pricing for consumers and increase record-keeping duties. A brief cash flow forecast usually clarifies whether registration supports the business model.

Choosing a VAT accounting scheme: Standard, Flat Rate, Cash Accounting, and Annual Accounting

How the main VAT accounting schemes differ

After VAT registration, a business must choose how to account for VAT. The choice affects cash flow, record keeping, and the timing of VAT payments. HMRC offers several schemes for small businesses, each with clear eligibility rules and practical trade-offs. Check the latest scheme conditions on GOV.UK (VAT accounting schemes) before selecting an option.

Standard VAT accounting (the default)

Under Standard VAT accounting, a business charges VAT on sales and reclaims VAT on purchases in the normal way. VAT returns usually run quarterly. A business accounts for VAT based on invoice dates, not on when customers pay. As a result, a firm can owe VAT to HMRC even when an invoice remains unpaid.

This scheme suits businesses with straightforward invoicing, stable cash flow, and a need to reclaim input VAT (VAT on purchases) in full. It also fits firms that do not meet the entry rules for other schemes.

Flat Rate Scheme (FRS)

The Flat Rate Scheme simplifies VAT calculations by applying a fixed percentage to VAT-inclusive turnover, rather than tracking VAT on every purchase. A business still charges customers the normal VAT rate, yet pays HMRC the flat rate percentage for the relevant trade sector. In most cases, a firm cannot reclaim input VAT on day-to-day purchases under FRS, with limited exceptions.

FRS can reduce admin time, yet it does not always reduce VAT costs. A business that buys significant VATable goods or services often finds Standard VAT more favourable. HMRC also applies specific rules to “limited cost traders”, which can increase the flat rate percentage and reduce the benefit. Review the current guidance on GOV.UK (VAT Flat Rate Scheme).

Cash Accounting Scheme

Cash Accounting links VAT to payments rather than invoices. A business pays output VAT only when customers pay, and reclaims input VAT only when the business pays suppliers. This approach can protect cash flow where customers pay late or where sales fluctuate.

Cash Accounting can suit trades with long payment terms, such as business-to-business services. However, it can delay VAT reclaims on large purchases when a firm negotiates extended supplier credit. Confirm eligibility and limits on GOV.UK (VAT Cash Accounting Scheme).

Annual Accounting Scheme

Annual Accounting reduces the number of VAT returns to one per year. A business makes interim payments during the year, then submits a single VAT return to reconcile the position. This structure can help budgeting and reduce the frequency of reporting tasks.

Even so, Annual Accounting does not remove the need for accurate records throughout the year. A business must still keep VAT records and comply with Making Tax Digital requirements where applicable. See GOV.UK (VAT Annual Accounting Scheme) for current rules.

A practical way to choose

• Prioritise cash flow: choose Cash Accounting if late payment risk is common.
• Prioritise simplicity: consider FRS or Annual Accounting, then test the cost impact.
• Prioritise VAT recovery: Standard VAT often suits firms with regular VATable costs.
• Check sector fit: FRS percentages vary by trade, so confirm the correct category with HMRC.

Before committing, compare the likely VAT payable under each scheme using recent sales and purchase figures. A business can usually change schemes, yet timing rules apply, so plan the switch around VAT periods and cash commitments.

VAT rates and liability: standard, reduced, zero-rated, and exempt supplies

VAT liability depends on how HM Revenue and Customs (HMRC) classifies each sale. The rate you charge affects pricing, invoices, and the VAT you can reclaim on related costs. Check current rates and examples on GOV.UK (VAT rates).

• Standard-rated (20%): the default rate for most goods and services. Charge VAT and reclaim input VAT (VAT on business purchases) where the normal rules allow.
• Reduced-rated (5%): applies to specific supplies, such as certain energy-saving materials and domestic fuel and power in defined cases. Charge VAT at 5% and reclaim input VAT as usual.
• Zero-rated (0%): VAT applies at 0%, often for items such as most food and children’s clothing. These sales still count as taxable turnover for registration, and input VAT recovery normally remains available.
• Exempt: no VAT is charged, and exempt income does not count towards taxable turnover. Input VAT linked to exempt sales is usually not recoverable, which can increase costs.

Classify each product or service at line level, since mixed supplies can create errors. Keep evidence for the chosen treatment, especially where a relief depends on product type, customer status, or how the item is used. When a supply does not fit clearly, use HMRC guidance or seek professional advice before issuing invoices.

Digital compliance: Making Tax Digital for VAT, software, and record-keeping rules

Making Tax Digital (MTD) for VAT remains a core compliance requirement in 2026. Most VAT-registered businesses must keep certain VAT records in a digital form and submit VAT Returns to HM Revenue and Customs (HMRC) using MTD-compatible software. HMRC publishes the current scope, exemptions, and sign-up guidance on GOV.UK. Even when a business uses an agent, the legal responsibility for accurate records and timely submissions stays with the business.

MTD affects three practical areas: record keeping, “digital links”, and submission method. Digital record keeping means you store key VAT data electronically, such as the time of supply (tax point), value excluding VAT, VAT rate, and VAT amount. A digital link means the transfer of data between software products happens electronically, without manual copying and pasting. For example, a spreadsheet can form part of the process, yet the figures must flow into the VAT Return through a digital link rather than re-keying totals.

Software choice should match how the business invoices, takes payments, and tracks expenses. Many firms use accounting platforms that connect directly to HMRC for VAT filing, while others use bridging software to submit VAT Returns from spreadsheets. Before committing, confirm that the product appears on HMRC’s list of compatible software and that it supports the VAT scheme in use, such as Cash Accounting or Flat Rate. HMRC maintains the compatibility list on GOV.UK.

Record-keeping discipline reduces errors and enquiry risk. Reconcile sales and purchase ledgers to bank activity, retain VAT invoices and import documentation, and document any adjustments, such as partial exemption calculations or corrections under the error rules. Set internal deadlines ahead of the filing date to allow time for checks, especially where multiple systems feed the VAT figures.

VAT on common small business transactions: imports, exports, services, and online sales

VAT treatment often changes by transaction type. Clear rules help you price correctly, issue compliant invoices, and avoid errors on the VAT Return. HM Revenue and Customs (HMRC) sets detailed guidance for each scenario on GOV.UK.

Imports (goods brought into Great Britain) usually create import VAT at the border. Many VAT-registered businesses use postponed VAT accounting, which lets you account for import VAT on the VAT Return instead of paying it upfront, subject to eligibility and correct customs declarations. Keep import paperwork and statements, as you will need evidence to reclaim input VAT.

Exports (goods sent from Great Britain to customers abroad) often qualify for zero rating when you meet conditions and hold proof of export. You still record the sale on your VAT Return, yet you charge VAT at 0% rather than 20%. Missing evidence can lead to HMRC treating the sale as UK taxable, so retain shipping and commercial documents.

Services depend on the “place of supply” rules, which decide where a service is treated as supplied for VAT. Business-to-business services commonly follow the customer’s location, while business-to-consumer services often follow the supplier’s location, with notable exceptions. When the reverse charge applies, the customer accounts for VAT, and your invoice should state that the reverse charge applies.

Online sales require extra care where platforms, distance selling, and customer location affect VAT. For goods sold to UK consumers, you usually charge UK VAT at the correct rate. For cross-border sales, check whether you must register abroad or use a simplification scheme where available.

• Confirm customer status and location (business or consumer, UK or overseas).
• Use correct evidence: export proof, import statements, and customer VAT numbers where relevant.
• Match VAT coding in your accounting software to the transaction type to reduce MTD errors

Reclaiming input VAT: evidence, partial exemption, and common restrictions

Input VAT is the VAT a business pays on purchases and expenses. A VAT-registered business can usually reclaim input VAT on costs that relate to taxable sales (standard-rated, reduced-rated, or zero-rated). To support a claim, keep valid VAT invoices and import evidence, and ensure the purchase links to business activity. HM Revenue and Customs (HMRC) sets out the evidence rules and invoice requirements on GOV.UK (VAT record keeping).

Evidence needs to match the transaction. For UK purchases, a VAT invoice should show the supplier VAT number, invoice date, tax point, description, and VAT amount. For imports, retain customs declarations and postponed VAT accounting statements where relevant. When a receipt does not meet invoice standards, treat the VAT as non-reclaimable unless the supplier can issue a compliant invoice.

Partial exemption affects businesses that make both taxable and VAT-exempt supplies. Exempt income (such as many financial, insurance, and certain education services) can restrict recovery because input VAT that relates to exempt supplies is not recoverable, subject to de minimis limits. Mixed-use costs often need an apportionment method that is fair and reasonable, applied consistently, and supported by workings. HMRC explains partial exemption methods and thresholds on GOV.UK (VAT partial exemption).

Several common restrictions catch small businesses. You cannot reclaim VAT on most business entertainment, and you must apply special rules to motoring costs, especially when private use exists. If a purchase supports non-business activity, recovery is blocked or reduced. Capital items can also trigger longer adjustment periods under the Capital Goods Scheme, which can change recovery when use changes over time. Check the latest restrictions and examples on GOV.UK (VAT Guide) before submitting the VAT Return.

Reducing VAT risk: returns, payments, penalties, and preparing for HMRC checks

Get the basics right on every VAT Return

Most VAT risk comes from routine errors. A simple, consistent process reduces mistakes and protects cash flow. Start each return by reconciling sales and purchase records to the figures in the VAT account. Check that each invoice uses the correct VAT rate and that the tax point (the date that sets when VAT becomes due) matches the period you are filing.

Before submission, review the key boxes for common issues:

• Box 1 and Box 4: output VAT (VAT charged to customers) and input VAT (VAT on purchases) should match supporting records.
• Box 6 and Box 7: these show net values, not VAT. Misposting gross figures can distort turnover and trigger questions.
• EC and international entries: only include these when the transaction type requires it, and keep evidence that supports the VAT treatment.

Where a figure looks unusual, record a short explanation in your working papers. Clear notes help when staff change, and they also speed up responses to HMRC queries.

Pay on time and protect cash flow

Late payment creates avoidable cost and attention. Set internal deadlines several days before the filing date, then schedule payment as soon as you confirm the liability. Direct Debit can reduce the risk of missed payments, though the set-up timing matters. Confirm the current payment methods and deadlines on GOV.UK (Pay your VAT bill).

If cash flow tightens, act early. Contact HMRC before the due date to discuss a Time to Pay arrangement, and keep evidence that supports forecasts and affordability. HMRC explains the approach and contact routes on GOV.UK (If you cannot pay your tax bill on time).

Understand penalties and how to avoid them

HMRC uses a points-based system for late VAT Returns. Each late submission can add a point, and points can lead to a financial penalty once you reach a threshold. Separate penalties and interest can apply to late payment or errors. Since rules can change, check the current position on GOV.UK (VAT penalties and surcharges).

To reduce exposure, focus on prevention:

• Maintain a filing calendar with named owners and cover for holidays.
• Lock down VAT codes in accounting software to limit ad hoc changes.
• Review high-risk areas each quarter, such as mixed-rate sales and staff expenses.

Good VAT compliance relies on evidence and consistency: correct invoices, clear audit trails, and timely submissions.

Prepare for HMRC checks with an “audit-ready” file

HMRC may carry out a compliance check to confirm that returns match underlying records. Preparation reduces disruption. Keep an accessible pack for each VAT period that includes the VAT Return workings, key reconciliations, and supporting reports from your accounting system. Retain copies of VAT invoices, import documentation, and credit notes, and ensure that digital records meet Making Tax Digital requirements.

When HMRC asks questions, respond promptly and stick to the facts. Provide the specific documents requested, explain any one-off items, and correct errors using the proper route. HMRC sets out what to expect and how checks work on GOV.UK (HMRC compliance checks).