Zero rated and exempt sales both carry no VAT for the customer, but they are opposites for the seller. A zero rated supply is a taxable supply at 0%, so the seller can reclaim VAT on related costs and the sales count towards the registration threshold. An exempt supply is not a taxable supply, so VAT on related costs is normally irrecoverable and the sales do not count towards the threshold.

What does the law say about each?

Section 30(1) of the Value Added Tax Act 1994 provides that where a supply is zero rated, no VAT is charged on it, but it is “in all other respects” treated as a taxable supply, with the rate treated as nil. Zero rated supplies are those described in Schedule 8 (section 30(2)).

Section 31(1) makes a supply exempt if it is described in Part 2 of Schedule 9. Section 4(2) then defines a taxable supply as any supply made in the UK other than an exempt supply. So an exempt supply is not a lower rate of VAT; it sits outside the taxable regime. HMRC’s VAT guide (Notice 700, paragraphs 3.5 and 3.6) summarises the effect: zero rated supplies are treated as taxable in all respects including the right to recover VAT on business expenditure, while for exempt supplies no tax is payable but the person making them cannot normally recover any of the VAT on their own expenses.

Schedule 9 groups include insurance (Group 2), postal services (Group 3), betting, gaming and lotteries (Group 4), finance (Group 5), education (Group 6), health and welfare (Group 7) and burial and cremation (Group 8), as well as many property transactions. The full map of rates is in VAT rates: standard, reduced and zero.

Why can a zero rated business reclaim input tax?

Under section 26 of VATA 1994, input tax is recoverable only so far as it is attributable to taxable supplies (and to certain supplies outside the UK and specified exempt supplies). Because a zero rated supply is a taxable supply, VAT on costs used to make it qualifies. Notice 700, paragraph 10.2, confirms that input tax relating to standard, reduced or zero rated supplies can normally be reclaimed.

A business making mainly zero rated sales will often have more input tax than output tax, so its returns show a repayment. Section 25(3) requires HMRC to pay that excess as a VAT credit, and Notice 700, paragraph 20.3.2, lets a business that normally receives repayments ask for monthly returns to improve cash flow.

Why does exemption block recovery?

VAT on costs used to make exempt supplies is not attributable to taxable supplies, so section 26 gives no credit for it. Notice 700, paragraph 10.3, lists VAT relating to exempt supplies among the items that cannot normally be reclaimed. For a business making only exempt supplies, all VAT on its costs is a real cost.

A business making both taxable and exempt supplies is partly exempt and needs a partial exemption method to split its input tax (Notice 700, paragraph 13.1, and VAT Notice 706). There is relief for small amounts. Under Notice 706, paragraph 11.2, a business can treat itself as fully taxable for a period if its exempt input tax is no more than £625 a month on average and no more than half of its total input tax. Both conditions must be met. Notice 706 also offers two simplified tests that can save a full calculation. Our guide to VAT partial exemption covers the methods.

How do they affect VAT registration?

Registration depends on taxable turnover. GOV.UK confirms that taxable turnover includes zero rated, reduced rated and standard rated sales but excludes exempt and outside the scope sales. A business must register if taxable turnover for the last 12 months goes over £90,000, or is expected to go over £90,000 in the next 30 days, and does not have to register if it only sells exempt or outside the scope goods and services. See the VAT registration threshold guide for the timing rules.

A business whose taxable supplies are wholly or mainly zero rated can ask HMRC for exemption from registration. Schedule 1, paragraph 14 of VATA 1994 lets HMRC exempt a person from registration, at their request, where it is satisfied the supplies are or would be zero rated. The business must notify HMRC of any material change in the nature of its supplies and, under paragraph 14(3), of any material change in the proportion of zero rated supplies within 30 days of the end of the quarter. GOV.UK notes that a non established taxable person must have all of its taxable supplies zero rated to qualify.

Exemption from registration is a choice, not an automatic result. Many zero rated businesses prefer to register, because registration lets them reclaim input tax.

What does this look like in numbers?

Illustration only. Two businesses each make £100,000 of sales a year and buy £20,000 of standard rated goods and services, paying £4,000 VAT on top.

Bookseller (zero rated) Insurance intermediary (exempt)
Taxable turnover for registration £100,000 £0
Must register? Yes, unless HMRC grants exemption from registration No
VAT charged to customers £0 £0
Input tax recovered £4,000 £0
Net cost of purchases £20,000 £24,000

HMRC’s rates guide shows books at 0% and the services of insurance brokers and agents acting as intermediaries as exempt. Both businesses charge customers the same VAT, nothing, yet the exempt business carries £4,000 more cost.

Can an exempt supply ever allow recovery?

There are two important routes.

  • Specified supplies to overseas customers. Notice 700, paragraph 10.2, allows recovery of input tax on services supplied to a person belonging outside the UK, or directly linked to the export of goods, where the supply would be exempt under Group 2 (insurance) or items 1 to 8 of Group 5 (finance) of Schedule 9. Section 26(2)(c) provides the power for this.
  • The option to tax. Notice 700, paragraph 3.6, explains that a business can choose to standard rate certain property supplies that would otherwise be exempt, which brings related input tax into recovery. See our guide to the option to tax.

How are they different from outside the scope supplies?

Outside the scope supplies are not supplies for UK VAT at all. Notice 700, paragraph 3.2, gives three cases: supplies made by someone who is not a taxable person, supplies made outside the UK and the Isle of Man, and supplies not made in the course or furtherance of business. On the VAT return, VAT Notice 700/12 says Box 6 includes zero rated, reduced rate and exempt supplies, and certain outside the scope supplies, so all of these still need to be recorded accurately even though no VAT is charged.

What mistakes come up most often?

  • Assuming a business with only zero rated sales does not need to register. It does once taxable turnover passes the threshold, unless HMRC agrees to exempt it from registration.
  • Reclaiming VAT on costs that relate to exempt income, or ignoring the de minimis test, which requires both conditions to be met.
  • Describing exempt sales as zero rated on invoices. Notice 700, paragraph 16.5, requires a VAT invoice that includes zero rated or exempt items to show clearly that no VAT is payable on them, with a separate total for their value.
  • Failing to tell HMRC about a material change in the mix of supplies while exempt from registration.

The basic mechanics of charging and reclaiming are covered in how VAT works.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.