A village shop sells a customer a loaf of bread, a packet of chocolate digestives, a bottle of squash, a birthday card and a box of paracetamol. Four of those five items have different VAT treatments, and one of them has been argued over in a tribunal.
The bread is zero rated. The chocolate digestives are standard rated, because a biscuit wholly or partly covered in chocolate is excepted from the zero rating for food. The squash is standard rated as a soft drink. The card is standard rated. The paracetamol, sold over the counter, is standard rated too.
Multiply that by 900 transactions a week and you can see why HMRC provides schemes rather than expecting you to reason it out each time.
The rate depends on the item, not on your shop
Once you are VAT registered, every sale you make has a liability attached to it, and in a general retailer those liabilities are mixed.
The standard rate is 20%. The reduced rate of 5% covers a limited list including domestic fuel and power, children's car seats, and certain energy saving materials. Zero rating covers most food for human consumption, books and newspapers, children's clothing and footwear, and a handful of other categories. Exempt supplies, such as postage stamps at face value, are different again: no VAT is charged and the input tax relating to them is not recoverable.
The point that catches people is that zero rated is not the same as exempt and neither is the same as outside the scope. Zero rated sales count towards your VAT-taxable turnover for the registration threshold and appear on your return, they just carry VAT at 0%.
Food is where the complexity lives, because Group 1 of Schedule 8 to the Value Added Tax Act 1994 zero rates food and then sets out excepted items which return to the standard rate: confectionery, crisps and similar savoury snacks, ice cream, soft drinks, and anything supplied in the course of catering, including hot takeaway food.
The excepted items are drawn in a way that produces genuine disputes rather than obvious answers. Chocolate covered biscuits are standard rated; chocolate covered cakes are zero rated, which is why the Jaffa Cake tribunal in 1991 mattered and why it is still cited. Gingerbread men have historically turned on how much chocolate decoration they carry. Flapjacks and cereal bars have been litigated repeatedly. In 2024 the Upper Tribunal considered giant marshmallows intended for roasting and held them to be zero rated rather than confectionery.
None of this is trivia. If you sell a line at the wrong rate for three years, HMRC can assess for the underpaid tax across that period, and you cannot go back and collect it from your customers.
Retail schemes exist because the till cannot always tell you
If your electronic point of sale system reliably identifies the VAT liability of every item as it is scanned, you do not need a retail scheme. You work out your output tax from your records in the normal way, and that is the cleanest answer.
If it cannot, VAT Notice 727 sets out the retail schemes, which are approximations HMRC accepts.
The Point of Sale Scheme identifies the VAT due at the time of sale. It requires a till that can separate takings by rate, and it is the most accurate of the schemes because it is barely a scheme at all. If you can run it, run it.
The Apportionment Schemes work backwards from purchases. Apportionment Scheme 1 takes the value of goods you bought for resale at each rate and applies that mix to your takings. It is available to smaller retailers, with a turnover limit that has historically been £1 million excluding VAT. Apportionment Scheme 2 is more involved, uses expected selling prices, and applies to larger businesses up to a much higher ceiling.
The Direct Calculation Schemes work by calculating the expected selling price of your minority goods, the smaller of your standard rated or zero rated sales, and deducting that from total takings. They suit shops where one rate clearly dominates, such as a newsagent with a small standard rated range or a hardware shop with a few zero rated lines.
Above the largest scheme thresholds you must agree a bespoke retail scheme with HMRC. The thresholds and the detailed conditions are set out in Notice 727 and its sub-notices and they do change, so read the current version before choosing.
Two rules apply whichever you pick. You cannot chop and change: you normally use a scheme for a full year and change at your year end. And you must keep records of daily gross takings, which means every sale, including card, cash, gift card redemptions and staff purchases, recorded as it happens.
Your till file is your VAT return
The practical failure in retail VAT is rarely a misunderstanding of the law. It is a product file that nobody maintains.
Every line in your point of sale system carries a VAT code. If that code is wrong, it is wrong on every sale of that line until somebody notices, and nobody notices because the till does not complain. New lines added in a hurry at Christmas default to standard rate in most systems, which means every zero rated line added that way is costing you 20% of its selling price.
Build a review into the year. Export the product file, sort by VAT code, and look at the zero rated list and the standard rated list separately. Errors are usually obvious when the items are next to each other: the children's socks sitting at 20%, the box of chocolates sitting at 0%.
Watch the edges. Children's clothing is zero rated only up to certain size limits and only where it is designed for young children. Printed matter is zero rated but stationery is not, so a book is different from a diary. A hamper containing mixed rate goods is a mixed supply requiring apportionment. Hot food is standard rated while the same food cold may not be. Delivery charges normally follow the liability of the goods they relate to.
Making Tax Digital applies to all VAT registered businesses since April 2022. Your records must be kept digitally and the path from those records to the figures on your return must be a digital link rather than a retyped total. A retail scheme calculation done on a spreadsheet is fine, as long as the numbers flow into it and out of it digitally.
Keep your VAT records for six years, including till rolls or their digital equivalent, and your daily gross takings records. HMRC assurance visits to retailers routinely start by asking for a period's takings and tracing them through to the return.
Where this shows up in the game
Shops are part of Business Baron's full game, and e-commerce is one of the five business types in the free game. VAT is calculated to the penny, with the rate table changing underneath you from its arrival in April 1973, and the quarterly payment lands whether or not the cash is still in the account. It is the clearest demonstration that turnover is not money.