What is VAT zero-rating and how does it differ from VAT exemption?
Zero-rating means VAT is charged at 0 percent on the supply. Unlike exemption, zero-rating allows the supplier to recover input VAT on costs related to making zero-rated supplies. Common zero-rated supplies include exports, most food in the UK and Ireland, children's clothing (UK), and pharmaceutical products in some jurisdictions. The key distinction from exemption: zero-rated businesses are still VAT-registered and file returns.
Why does the distinction between zero-rating and exemption matter?
The distinction between zero-rating and exemption is critical for input VAT recovery. A business making zero-rated supplies (e.g., an exporter) charges 0 percent VAT to customers but retains the right to recover all input VAT on business costs. A business making exempt supplies (e.g., a financial services firm) does not charge VAT to customers AND cannot recover input VAT on costs related to exempt activities. This makes exemption economically costlier than zero-rating for suppliers.
Frequently Asked Questions
- What is the VAT treatment of international services?
- International services supplied B2B between businesses in different countries are typically zero-rated or outside scope in the supplier's country, with the customer in their own country applying reverse charge. For B2C international services, OSS or individual country registration may be required. Export zero-rating applies when evidence confirms the supply is for use outside the VAT territory.
- How should invoices for zero-rated supplies be structured?
- Invoices for zero-rated supplies should show the supply amount, the VAT rate as 0 percent, and the VAT amount as zero. Some jurisdictions require a notation explaining the basis for zero-rating (e.g., 'Zero-rated export' or reference to the applicable VAT legislative provision). For EU intra-community zero-rated supplies, the customer's VAT number and a note that the supply is an intra-community supply must appear on the invoice.