At first glance, the terms ‘zero-rated VAT’ and ‘VAT exempt’ might sound like they mean the same thing. But when it comes to how UK businesses charge customers and reclaim VAT, the differences are pretty striking.

In this article, we’ll break down the key distinctions between zero-rated and VAT exempt goods and services, explain what they mean for your business and clear up common points of confusion so you can stay compliant (and sane!).

What is VAT, again?

Just to recap, VAT (Value Added Tax) is a tax charged on most goods and services sold in the UK. If you're VAT registered, you usually:

• Charge VAT on your sales (this is called output tax)
• Pay VAT on business purchases (input tax)
• Submit a VAT return to HMRC, paying the difference or claiming a refund

But not everything is taxed at the standard VAT rate (currently 20%). Some goods and services qualify for reduced rates, zero rates or are exempt altogether. Let’s break down what this all means:

What does ‘zero-rated VAT’ mean?

Goods and services that are zero-rated are still taxable for VAT purposes, but the rate of VAT you charge is 0%.

That might sound the same as ‘VAT exempt’, but there’s one key difference: if you sell zero-rated goods, you can still reclaim the VAT you pay on business expenses related to those sales.

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Here are some examples of zero-rated items that you could reclaim VAT on:

• Most food and drink (excluding things like alcohol or restaurant meals)
• Children’s clothing and shoes
• Books and newspapers
• Public transport fares
• Exported goods

What does ‘VAT exempt’ mean?

If something is VAT exempt, it isn’t taxed at all because it falls completely outside the scope of VAT. That means you don’t charge VAT to customers, and crucially, you can’t reclaim the VAT on related purchases either.

Here are some items which are commonly VAT exempt:

• Insurance services
• Education and training provided by eligible bodies
• Health services provided by registered professionals
• Certain financial services (like loans, credit or investment management)

Why does the distinction matter?

Here’s where it gets practical. Let’s say you’re a business that sells both zero-rated and exempt goods. How you treat your VAT reclaim depends on this split.

• If you mostly sell zero-rated goods, you can reclaim most or all of the VAT you pay on business purchases.
• If you mostly sell VAT exempt goods, you might not be eligible to reclaim VAT, or your reclaim will be restricted.

For example, a children’s clothing shop selling zero-rated products can usually reclaim VAT on everything from rent to stationery. A tuition provider offering VAT-exempt lessons? Not so much.

How all of this affects VAT registration

Whether you need to register for VAT depends on your VAT taxable turnover (with the VAT threshold currently sitting at £90,000 a year, as of 2025).

Only zero-rated sales count towards your VAT taxable turnover. If you’re below the threshold but only sell zero-rated goods, you can choose to apply for VAT exemption from registration. However, this also means you can't reclaim VAT on expenses.

On the other hand, VAT exempt sales don’t count towards the VAT threshold at all. So, you could be turning over £95,000 in exempt sales and still not be required to register.

Partial exemption and mixed supplies

If you make both taxable (standard, reduced or zero-rated) and exempt sales, you may fall under the partial exemption rules.

This means you’ll need to:

• Separate out the VAT on your business purchases
• Only reclaim VAT on costs that relate to your taxable (non-exempt) sales
• Use a fair and reasonable method to work out how much you can reclaim

This can get fiddly fast, so it’s worth talking to an accountant or tax professional (like one of our friendly team at Crunch) if you’re in this situation.

Common misconceptions

Here are a few of the things that UK businesses think which may make them trip up:

1. "VAT exempt and zero-rated are the same thing."‍

Not quite. Zero-rated items are taxable at 0%. VAT exempt items fall outside the VAT system entirely.

2. "If I only sell zero-rated goods, I don’t need to register for VAT."‍

Not necessarily. You’ll still need to register if you pass the £90,000 VAT threshold.

3. "Being VAT exempt is better because I don’t have to deal with VAT at all."‍

That depends. While you avoid charging VAT, you also can’t reclaim it - which will impact your cashflow on a short term basis could cost you more in the long run.

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Should you register for VAT if you sell zero-rated goods?

This is a common question for new businesses, especially in sectors like food or children’s clothing. Even if you’re under the threshold, voluntary VAT registration can be worthwhile if:

• You want to reclaim VAT on setup costs (like premises or equipment)
• Your customers are VAT registered and can reclaim any VAT you charge

That said, voluntary registration means extra admin and quarterly VAT returns, so it’s not always the right move. Weigh up the pros and cons, or better yet, chat with a professional who will be able to help you make the right choice for your business’ specific situation.

Feeling clearer on the differences between ‘zero-rated’ and ‘VAT exempt’?

Understanding the difference between zero-rated VAT and VAT exempt goods will play an important part in how you price your products, reclaim expenses and report to HMRC.

Get it wrong, and you could end up undercharging customers or missing out on VAT you could have reclaimed. Get it right, and you’ll be making smarter decisions that protect your margins and keep you HMRC compliant.

If you’re unsure how VAT applies to your business, Crunch’s expert accountants are always here to help you navigate the fine print. Whether you’re registering for VAT, handling mixed supplies or planning your pricing strategy, we’ve got your back. Speak to one of our friendly team today to find out more. 

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