Confused by 5% and 20% VAT? Here’s How It Really Works
Posted on 24th October 2026 by Aidan Miller
VAT can become confusing when a business supplies goods or services that fall under different VAT rates. We recently worked with a client who was struggling to understand why the business was regularly receiving VAT refunds, despite charging VAT on its sales.
The business carried out a mixture of work that was subject to both the standard VAT rate of 20% and the reduced VAT rate of 5%. Under HMRC rules, the standard rate of 20% applies to most goods and services, while the reduced 5% rate applies to certain qualifying supplies, including some energy-saving and residential property-related work.
The client had become focused on the idea of a “net VAT rate” of 15%, assuming that the different rates effectively averaged themselves out. In reality, VAT doesn’t work this way. Businesses calculate VAT by comparing the VAT charged on sales (output VAT) with the VAT paid on business purchases and expenses (input VAT). The difference determines whether VAT is payable to HMRC or whether a refund is due.
When we reviewed the figures together, it became clear that most of the client’s sales were being invoiced at 5%, while the majority of his purchases carried VAT at 20%. As a result, the amount of VAT he was recovering on costs was often higher than the VAT he was charging customers, creating a refund position.
To put this into perspective, a business that charges £5,000 plus 5% VAT on its sales would collect £250 of VAT from customers. If that same business incurred £3,000 plus 20% VAT on purchases, it would have paid £600 of VAT to suppliers. In this simple example, the business would be due a VAT refund of £350. While real-life calculations can be more complex, this illustrates how lower-rated sales and higher-rated purchases can create regular VAT repayment claims.
Once the numbers were broken down and explained in plain English, everything clicked into place. The client not only understood why refunds were arising but also gained confidence in how VAT works within his business.
Next Steps
If your business carries out work that falls under different VAT rates, it’s worth taking the time to understand how each transaction affects your overall VAT position. A simple review of your sales and purchases can often reveal why VAT liabilities or refunds arise. Getting this right helps improve cash flow forecasting, reduces confusion, and gives you greater confidence that your VAT returns are accurate.
If you’re unsure whether you’re applying the correct VAT rates, or you’d like a clearer understanding of why your business is paying VAT or receiving refunds, professional advice can save significant time and prevent costly mistakes. VAT legislation can be complex, particularly where reduced-rate supplies, property-related services, or mixed-rate activities are involved.
We’re always here to help business owners make sense of VAT by translating technical rules into practical, easy-to-understand advice. Whether you need support with VAT registrations, return preparation, compliance reviews, or simply understanding your VAT position, we’re here to help.
Take a look at our website for further information : https://stevenburtonandco.com/services/business/
Or simply contact us if you want to run something by a second pair of eyes – https://stevenburtonandco.com/contact-us/
The Steven Burton & Co team are here to help you. If you need a sounding board, some advice or a steer in the right direction, then please don’t hesitate to get in touch.
Finally ……
This material has been prepared for informational guidance purposes only. Whilst every effort has been made to ensure the contents are accurate, information contained may not be comprehensive. Furthermore, it is not intended to provide, and should not be relied on for, tax or accounting advice. Steven Burton & Co Limited can not accept any liability for any errors or omission or for any person acting on or refraining from acting on the information provided. Steven Burton & Co Limited are not financial advisors.
Aidan is Studying Level 3 AAT and has plans of studying further to ACCA level to be able to give accurate and relevant advice to clients to make sure that they continue to function efficiently, smoothly and profitably.
Aidan works with accounting software (Xero, QuickBooks and Dext) to deliver genuine and accurate daily bookkeeping as well as VAT returns and to assist with tax returns and other crucial client work.
Outside of the office Aidan regularly plays Rugby for Colchester rugby club and gets out on the golf course as much as possible.
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info@stevenburtonandco.com
