Understanding the difference between zero-rated and VAT exempt goods is an important part of running a business in the UK. Many owners get these two categories mixed up, as both mean you charge no VAT to the customer. However, the rules behind them are completely different, and getting them wrong can lead to issues with your VAT returns, pricing and HMRC compliance.
This guide explains what each term means, how they affect your VAT position and what every UK business needs to know to stay compliant. By the end, you will have a clear idea of how zero-rated and exempt supplies work and how they impact your VAT registration, record-keeping and reclaim rules.
What is VAT?
Value Added Tax, known as VAT, is a tax charged on most goods and services sold in the UK. It is applied at different rates depending on what is being sold. VAT is collected by businesses on behalf of HMRC vat rules, and the amount you charge or reclaim depends on the nature of your supplies.
Most businesses know the standard VAT rate is 20 percent, but not everything is charged at this level. Some items are charged at a reduced rate, others are zero-rated, and some are completely VAT exempt. These differences matter because they affect your pricing, your VAT returns, and your ability to reclaim VAT on your business costs.
Understanding whether your goods or services fall under zero-rated or VAT-exempt rules is essential for staying compliant and avoiding mistakes with HMRC.
Understanding Zero-Rated VAT
What does zero-rated VAT mean?
Zero-rated VAT means the goods or services you sell are still VAT taxable, but the rate charged is zero percent. You must record these sales in your VAT return, even though you are not adding VAT to the price.
Because zero-rated items are taxable supplies, businesses that sell them can still register for VAT and reclaim VAT on their eligible expenses. This is one of the biggest advantages of zero-rated status.
Examples of zero-rated goods and services
Some of the most common zero-rated items include:
- Most food sold in supermarkets, unless it falls under exceptions such as hot food or confectionery
- Children’s clothing and footwear
- Books, newspapers, leaflets and other printed reading materials
- Public transport fares
- New residential buildings
- Water supplied to households
- Charity advertisements
- Exports of goods outside the UK
- Prescription medicines
These categories are set by law, and detailed lists are provided by HMRC to help businesses classify their supplies correctly.
Conditions required for zero-rated VAT to apply
Zero-rating often depends on meeting specific conditions. For example:
- Children’s clothing must be for under 14s and meet size guidelines
- Food must not be hot, eaten on-site, or considered a luxury (for example, crisps or chocolate bars)
- Printed materials must fit the definition of a book or leaflet and not be mostly promotional
- Exports must be shipped outside the UK and supported with valid export evidence
If these conditions are not met, the supplies may switch to standard rate VAT, which can lead to errors in reporting.
How zero-rating affects pricing
Because VAT is charged at zero percent, the customer pays no VAT on the final price. The business still records the sale as a VATable supply, but the value does not increase for the buyer.
For example:
- A zero-rated product sold for £20 means the customer pays £20.
- A standard-rated product sold for £20 becomes £24 after VAT is added.
This can make zero-rated goods more appealing in price-sensitive markets.
Here are some examples of zero-rated items that you could reclaim VAT on
Even when selling zero-rated goods, you may still reclaim VAT related to:
- Manufacturing costs
- Business equipment
- Warehouse and storage costs
- Packaging
- Transport and delivery fees
- Professional services such as accountancy
- Marketing or advertising that promotes zero-rated goods
- Utility bills used for producing or storing zero-rated items
This is one of the main reasons many businesses dealing mainly in zero-rated goods still choose to register for VAT.
Understanding VAT Exemption
What does VAT exemption mean?
VAT-exempt supplies are not taxable at any rate. If you sell exempt goods or services, you cannot charge VAT to your customers, and you normally cannot reclaim VAT on related expenses.
Exempt supplies fall into categories that HMRC has defined in law. They are usually linked to areas such as health, education, insurance, and financial services.
Examples of VAT-exempt goods and services
Common exempt goods and services include:
- Health services provided by registered medical professionals
- Private tuition in school subjects
- Financial services such as loans, insurance, and credit
- Postal services provided by the Royal Mail
- Betting, gaming, and lottery activities
- Welfare services by some charities
- Rentals of residential properties
These supplies fall outside the VAT system, so they are not included in VAT returns for output tax.
How VAT exemption affects pricing
Because exempt supplies sit outside the VAT system, they do not attract VAT. However, unlike zero-rated sellers, exempt businesses cannot reclaim VAT on most related business expenses.
For example, a private tutor does not charge VAT on lessons. However, if the tutor purchases equipment, books, or software that includes VAT, they cannot claim that VAT back.
This can increase operating costs, which may lead to higher prices even though VAT is not charged to customers.
Key Differences Between Zero-Rated and VAT-Exempt Supplies
Zero-rated and exempt supplies may look similar to customers because no VAT is added to the price. However, they are treated very differently for VAT reporting and reclaim rules.
Key differences include:
- Zero-rated supplies are taxable, exempt supplies are not
- Zero-rated businesses can reclaim VAT, exempt businesses usually cannot
- Zero-rated sales must be included in VAT returns, exempt sales do not count as taxable turnover
- Zero-rated sales contribute to the VAT registration threshold, exempt sales do not
Comparing zero-rated and VAT-exempt supplies
|
Feature |
Zero-Rated |
VAT Exempt |
|
VAT charged |
0 percent |
None |
|
Included in VAT return? |
Yes |
No |
|
Counts toward VAT registration threshold? |
Yes |
No |
|
Can reclaim VAT on expenses? |
Yes |
Usually no |
|
Considered taxable supplies? |
Yes |
No |
Impact on VAT reclaims
The ability to reclaim VAT is the biggest difference. If your business sells only exempt goods, you are generally unable to recover VAT on:
- Equipment
- Supplies
- Professional services
- Rent
- Utilities
This can reduce profitability if your costs include VAT.
Zero-rated sellers, on the other hand, can reclaim VAT even though they charge none to customers.
Partial exemption and mixed supplies
Some businesses supply both taxable (including zero-rated) and exempt items. Examples include:
- Schools selling both tuition (exempt) and uniforms (zero-rated)
- Financial advisers selling exempt services and digital guides (standard-rated)
- Residential landlords also renting commercial units
If you supply both types, you may fall under partial exemption rules.
This means you’ll need to:
- Track input VAT separately for taxable and exempt activities
- Apportion VAT on mixed-use expenses
- Complete annual adjustment calculations
- Keep detailed VAT records showing how values were worked out
Partial exemption can be complex, and many businesses seek help to avoid errors in their VAT returns.
Can goods or services be both zero-rated and exempt?
No item can be both zero-rated and exempt at the same time. They are different categories with different rules. However, a business can supply a mix of zero-rated and exempt items.
For example, a charity shop may sell donated goods that are zero-rated, while also providing welfare services that are exempt.
Navigating VAT Rules
VAT rules can feel complicated, especially when you work with products or services that have special rates or strict conditions. Zero-rated and exempt supplies are two areas where businesses often make mistakes. The key to staying compliant is understanding how HMRC defines each category and checking the details before applying a VAT rate.
Because the VAT treatment depends on things like purpose, size, usage and legislation, it is important to review the rules carefully. When in doubt, seeking advice early can prevent errors and help you manage your VAT position with confidence.
Identifying zero-rated and exempt items
The first step is to check HMRC’s VAT guide and confirm the category your goods or services fall into. Many errors happen because businesses assume that similar items are treated the same way.
Always check:
- HMRC’s official VAT Notice 701 series
- Product or service definitions
- Size and measurement rules (for clothing)
- Temperature and preparation (for food)
Small details can change the VAT rate.
How to know whether your sales are zero-rated or exempt
To work it out:
- Check HMRC’s lists of zero-rated and exempt supplies
These lists define categories clearly. - Review your product or service in detail
VAT rules can depend on size, purpose or usage. - Check the exact wording of VAT notices
Some items appear similar but fall under different rules. - Consider whether the supply is mixed
You may need to separate the taxable and exempt parts.
Seeking expert advice
VAT can be complex, especially where supplies are mixed or where the classification depends on specific product rules. If you are unsure, getting professional advice early can prevent costly mistakes, reduce VAT risks and keep your records in line with HMRC expectations.
Accounting for Zero-Rated and Exempt VAT
Understanding how to record zero-rated and exempt sales is an important part of staying compliant with HMRC rules. Even though you are not charging VAT on these items, they still form part of your VAT records and may affect what you can reclaim.
Keeping your paperwork clear and consistent also helps you deal with HMRC checks, audits and VAT return queries. Below are the key areas you need to get right.
Proper invoicing
When supplying zero-rated items, your invoice must still show:
- Your VAT number
- The VAT rate applied
- A clear statement such as “Zero-rated supply”
For exempt supplies, you should mark the invoice as “VAT exempt”.
The invoice should also list the goods or services in enough detail so HMRC can understand why the item falls under that VAT category.
Good invoicing helps avoid delays, disputes or questions from HMRC.
Keep accurate records
Both zero-rated and exempt transactions must be recorded properly in your VAT records. This includes:
- Sales invoices
- Purchase invoices
- Credit notes
- Evidence to support the VAT category
Examples of evidence include product descriptions, contracts, shipping records or paperwork showing why an item is zero-rated, such as proof of export.
These records must be kept for at least six years.
Include zero-rated transactions in VAT returns
Zero-rated sales are still “VAT taxable supplies”, which means you must include them in your VAT return under the VAT taxable sales section.
This matters because:
- Zero-rated sales count towards your VAT registration threshold
- They help HMRC understand your VAT position
- They support your VAT refund claims
Exempt sales are also reported but are treated differently because they do not count as taxable supplies.
Comply with VAT rules
To stay compliant:
- Apply VAT rates correctly
- Keep evidence to support the VAT rate used
- File returns on time
- Only reclaim VAT you are entitled to
If you are partly exempt, special rules apply because claiming VAT becomes more complicated.
If you are unsure how the rules apply to your business, speaking with a VAT professional is often the safest approach.
VAT refund claims
If your business makes zero-rated sales, you may be entitled to reclaim VAT on related purchases. This often happens in industries such as:
- Food production
- Charities
- Books and printed material
- Children’s clothing
- International trade
If your input VAT (VAT you pay on purchases) is higher than the VAT you charge, you can request a refund through your VAT return.
Exempt supplies generally do not allow VAT reclaims, except in some partial exemption cases.
How to account for and reclaim zero-rated VAT
To reclaim zero-rated VAT correctly:
- Keep all invoices for purchases
- Record each invoice in your accounts
- Ensure the purchases relate to your taxable (including zero-rated) supplies
- Report input VAT on your VAT return
- Retain evidence that links the purchases to your business activity
HMRC may request supporting documents, so it is important that everything is clearly recorded and easy to find.
Common Misconceptions
VAT rules can be confusing, and many business owners make assumptions that lead to errors. Here are the misconceptions we see most often.
“VAT exempt and zero-rated are the same thing.”
This is one of the most common misunderstandings. While both result in no VAT being charged, the rules behind them are very different.
- Zero-rated goods are still taxable supplies at 0 percent
- Exempt goods are outside the VAT system
Because of this difference, zero-rated goods allow businesses to reclaim VAT, while exempt goods usually do not.
“If I only sell zero-rated goods, I don’t need to register for VAT.”
This is not correct. Zero-rated sales still count toward the VAT registration threshold. If your business turnover from taxable supplies (including zero-rated sales) goes above the threshold, you must register.
Being below the threshold is the only reason you would not need to register.
“Being VAT exempt is better because I don’t have to deal with VAT at all.”
Not always. Being exempt means you:
- Cannot reclaim VAT on your purchases
- May end up paying more overall
- Cannot charge VAT even if customers expect it
Many businesses prefer zero-rated status because it allows input VAT refunds.
Feeling clearer on the differences?
These rules can still feel confusing at first, but understanding the basics will help you avoid common mistakes. If you are unsure, it is often worth getting advice so that you apply the correct VAT treatment from the start.
VAT Registration Considerations
VAT registration decisions can be affected by whether your supplies are zero-rated or exempt. Some businesses choose to register voluntarily because it benefits their cash flow or allows them to reclaim VAT.
How VAT registration is affected
Your VAT registration status is influenced by:
- The value of your taxable supplies
- Whether your sales are zero-rated, reduced or standard rate
- Whether your business makes exempt supplies
Exempt supplies do not count toward the VAT threshold. Zero-rated supplies do.
If you only make exempt sales, you cannot normally register for VAT.
Should you register for VAT if you sell zero-rated goods?
Registering can be a good idea if:
- You buy a lot of stock or equipment with VAT
- Customers are VAT registered and can reclaim VAT
- You want to claim VAT refunds regularly
However, registering can create extra admin, so each business should weigh up the benefits and costs carefully.
Why the distinction between zero-rated and exempt matters
This distinction affects:
- Pricing
- VAT registration
- VAT reclaim ability
- Profit margins
- Cash flow
- Compliance obligations
Understanding these differences ensures you avoid penalties, price your goods correctly and complete VAT returns accurately. Getting these rules wrong can lead to HMRC queries or unexpected tax bills.
Frequently Asked Questions
What is zero VAT?
Zero VAT means the item is taxable at 0 percent. You must include the sale in your VAT return, and you can normally reclaim VAT on related purchases.
What goods are VAT zero-rated?
Common examples include:
- Most food
- Children’s clothing
- Books and eBooks
- New house-building
- Exports outside the UK
HMRC provides a full list in VAT Notice 701.
What does exempt VAT mean?
Exempt VAT means no VAT is charged, and the item is outside the VAT system. You cannot reclaim VAT on related purchases unless special partial exemption rules apply.
What is the difference between VAT-exempt and zero-rated?
The main differences are:
- Zero-rated items are taxable at 0 percent, exempt items are not taxable
- Zero-rated sales count toward VAT registration, exempt sales do not
- Zero-rated supplies allow VAT reclaims, exempt supplies usually do not
Can you reclaim VAT on zero-rated supplies?
Yes. As long as purchases relate to taxable supplies, including zero-rated sales, you can reclaim input VAT.
