How to Calculate VAT on Ecommerce Orders Step by Step

Calculating the correct VAT on e-commerce orders is critical for accurate pricing and VAT accounting. Any error can reduce your margin, result in an erroneous VAT liability, and require more labour when reconciling accounting. This guide describes the VAT calculation process for e-commerce orders in detail, including how each step impacts accounting and tax records.

What VAT Means for E-Commerce Orders

Value-added tax (VAT) is a kind of consumption tax applied to the vast majority of goods and services. Currently, the usual VAT rate in the UK is 20%. Some goods and services are subject to a 5% reduction or a 0% reduction. The VAT rate on most goods and kids’ clothing is nil. Other products, such as children’s car seats, have a lower VAT rate. The VAT computation for ecommerce orders is determined by the VAT categorisation of the products and services, as well as the nature of the transaction. Delivery charges should be carefully evaluated. If delivery is included in a single supply of goods, its VAT treatment is the same as the goods’.

Step 1: Decide Whether You Should Charge VAT

To calculate VAT, first establish if VAT is applicable to the sale and who is responsible for it.

• A VAT-registered firm normally charges VAT at the appropriate rate on its UK sales and reports this as output VAT on its VAT return.
• If a company is not VAT registered, VAT is typically not applied on sales, and they cannot recover VAT on their expenses. However, registration is necessary when the turnover exceeds £90,000 in a rolling 12-month period, or when the expected turnover exceeds £90,000 during the following 30 days.
• In the case of some overseas sales made using online marketplaces, the online marketplace can be considered the supplier for VAT purposes. This implies that if the items are sold outside of the UK, the consignment’s worth is less than £135, and the sale is conducted through an online marketplace to a UK client, the marketplace can be held liable for VAT.

This indicates that VAT can be influenced by variables other than whether one is VAT registered.

Step 2: Identify the Correct VAT Rate

If you have previously decided that VAT is applicable, look at the VAT rate for each good or service in the order.

• The standard rate is 20%, which applies to the majority of items and services.
• Reduced rate of 5%: This applies to specific items and services, such as domestic fuel and power and children’s car seats.
• Zero rate 0%: This applies to specific products and services, such as food and children’s clothes. A zero-rated transaction is taxable, but the customer cannot be charged VAT.

When an order includes items or services with different VAT rates, calculate the VAT separately for each line item. Using a single rate for the whole order can result in an inaccurate amount of VAT charged.

Step 3: Calculate VAT When Your Prices Are Net of VAT

If your ecommerce prices are shown excluding VAT, you add the relevant VAT at checkout.

Standard-rate example

Suppose a product is priced at £50 before VAT:

• Net price: £50
• VAT at 20%: £50 × 0.20 = £10
• Gross price: £50 + £10 = £60

You can also calculate the gross price directly by multiplying the net price by the relevant VAT factor:

• 20% VAT: £50 × 1.20 = £60
• 5% VAT: £50 × 1.05 = £52.50

For accounting purposes, the £50 is recorded as net sales and the £10 as output VAT.

Step 4: Calculate VAT When Your Prices Include VAT

If your ecommerce prices are VAT inclusive, the VAT is already included in the price shown to the customer. You therefore need to extract the VAT rather than add it.

For a product priced at £60 including VAT at 20%:

• Gross price: £60
• Net price: £60 ÷ 1.20 = £50
• VAT: £60 − £50 = £10

For a 5% VAT rate, divide the gross price by 1.05 to find the net amount.

You can also calculate the VAT directly using this formula:

VAT = Gross price × VAT rate ÷ (100% + VAT rate)

For example, at 20% VAT:

£60 × 20 ÷ 120 = £10 VAT

This approach is useful when your ecommerce platform displays VAT-inclusive prices, but your accounting records need the net sale and VAT shown separately.

Step 5: Include Shipping and Duties Where Required

For online deliveries from the UK, VAT calculations should include any applicable shipping expenses. The VAT treatment of the delivery cost is determined by whether it is included in the agreement to supply the products. In that case, the delivery charge is subject to VAT in the same way as the commodities are.

Example

Suppose you sell a standard-rated product for £50 and charge £5 for delivery:

• Product net price: £50
• Delivery charge: £5
• Total net amount: £55
• VAT at 20%: £55 × 0.20 = £11
• Gross amount: £66

The actual VAT treatment of delivery can differ depending on how it is delivered, so do not assume that all delivery expenses have the same rate as the items. Import VAT is normally calculated based on the customs value of the items. It can involve some transportation and insurance costs, as well as Customs Duty and other charges that must be applied in compliance with HMRC valuation standards.

For example, if the customs value of imported goods is £90 and £5 customs duty is payable, the amount utilised to calculate import VAT might be £95, assuming no additional adjustments are required:

• Customs value: £90
• Customs Duty: £5
• VAT value: £95
• VAT at 20%: £19

Import VAT would be £19.

The party responsible for VAT can differ depending on the nature of the transaction. For example, online marketplaces can be liable for UK VAT on some global items sold to UK clients, particularly shipments worth up to £135. Import VAT and Customs Duty are usually charged on consignments valued at above £135.

Step 6: Handle Mixed Baskets and Rounding

If the order includes goods with various VAT rates, the VAT must be calculated separately for each product before adding them together. It can help to prevent mistakes in the treatment of zero-rated, reduced-rated, and standard-rated items.

Example

• Item A: £40 at 20% VAT = £8 VAT and £48 gross
• Item B: £20 at 5% VAT = £1 VAT and £21 gross
• Shipping: £5 at 20% VAT = £1 VAT and £6 gross
• Total net amount: £65
• Total VAT: £10
• Total gross amount: £75

Differences in computation can occur due to rounding, especially if the VAT is calculated separately for each item. Make sure your ecommerce system employs the proper rounding approach.

Step 7: Reflect VAT Correctly in Your Accounting and Returns

VAT calculations performed correctly while paying at the cash register are only useful if the amounts are properly transferred into your accounts and VAT return.

• Output VAT means the amount of VAT charged on taxable sales. The VAT rates in the accounts should be appropriately separated so that they are accurately reported in your VAT return.
• Input VAT is the VAT paid by your company on eligible purchases and imports. It can normally be recovered if the spending is related to your business and the VAT is not banned or restricted.

Normally, the difference between output VAT and recoverable input VAT must be determined for each VAT period. If your output VAT exceeds the limit, you must pay the excess amount to HMRC. If your recoverable input VAT is higher, you can be eligible for a refund of the difference.

Sales on marketplaces require particular treatment. Before scheduling the deal, you must determine if you or the marketplace are liable for VAT payment on that transaction. For example, when an overseas firm sells items from outside the UK to a UK consumer via the marketplace website for a total shipping value of up to £135, the marketplace is responsible for charging and paying VAT. The remaining cases are handled differently. Your accounting records must reflect the exact nature of the VAT on the transaction rather than just crediting the income.

Common VAT Calculation Mistakes in E-commerce

VAT concerns are commonly raised in e-commerce purchases when the following occurs:

• The incorrect VAT rate is used: If you apply the 20% VAT rate on zero-rated and reduced-rated products, you can overcharge your clients and cause refund issues.
• Payouts are considered sales: Your payout is often the difference between your sales revenue and any deductions, such as refunds. As a result, it should not always reflect the gross value of sales.
• Deliveries are not taxed correctly: The VAT status of deliveries is determined by the mode of delivery and their link to the underlying products.
• The £135 rule is not considered. Some overseas items offered over internet marketplaces must account for UK VAT. Others can simply follow the standard procedures for importing products and paying import VAT.
• Incorrect VAT rates are used: separate goods in the same order should be charged at separate VAT rates.

Setting up your accounts efficiently guarantees that the appropriate amount of VAT received through e-commerce is credited to your VAT account.

How UK Ecommerce Accountants Can Help

Our e-commerce specialist accountant can help you with:

• Checking your product catalogue and verifying that each SKU is properly classified for UK VAT treatment.
• Defining the VAT computation rules for items, shipping costs, discounts, and promotions.
• Ensuring that your ecommerce software and accounting package are set up to accurately record VAT-inclusive and exclusive prices.
• Identifying net income and output VAT using the relevant VAT rate in your accounting.
• Checking marketplace transactions and choosing who should charge VAT: you or the platform.
• Matching the sales, commissions, refunds, and VAT from marketplaces such as Shopify, Amazon, and eBay in your bookkeeping.

This ensures that your online sales, VAT, and marketplace payments are regularly documented, and that your VAT return includes accurate accounting data.

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