Every default rate, what it does to the return once it is filed, and the handful of choices that produce a wrong figure without ever producing a warning. Written by a Chartered Management Accountant who files these returns.
Before taking any published list as read — this one included — open the organisation and look. The rates sit under Accounting, then Advanced, then Tax rates, and that screen is the only authoritative record of what a particular company has available and what each rate is composed of.
That matters more in Xero than people expect, for two reasons. The first is that the wording has moved. A rate that older guides call "20% (VAT on Income)" now appears as tax on revenue, and its counterpart reads as tax on purchases rather than expenses. Guidance written a few years ago describes rates by names that are no longer on screen, which is why a bookkeeper ends up hunting for an option that was simply relabelled.
The second is that a rate is a container, not a label. Each carries a component with a percentage attached, and a rate can be edited. Two organisations can both show something called "Zero Rated" and have it behaving differently.
| Rate | What it is for | Effect on the return |
|---|---|---|
| 20% on sales | Standard-rated supplies made by the business. The default for most invoices | Output tax in box 1, net in box 6 |
| 20% on purchases | Standard-rated costs where a valid VAT invoice is held | Input tax in box 4, net in box 7 |
| 5% on sales | Reduced-rated supplies — domestic fuel and power, children's car seats, certain installations | Output tax in box 1, net in box 6 |
| 5% on purchases | Reduced-rated costs, most often the energy bill | Input tax in box 4, net in box 7 |
| Zero Rated | Taxable at 0% — most food, children's clothing, books, printed matter, exported goods | No tax. Net still counted in box 6 or box 7 |
| Exempt | A supply the VAT charge does not reach — postage stamps, insurance, most finance, rent of certain property | No tax. Net still counted in box 6 or box 7 |
| No VAT | Movements that are not consideration for a supply — payroll, PAYE, drawings, dividends, inter-account transfers | Nothing. Absent from the return |
| Reverse charge rates | Supplies where the customer accounts for the tax instead of the supplier | See below — the boxes differ by type |
Standard, reduced and zero are the three rates HMRC operates; exempt and out-of-scope are separate ideas that happen to share a blank VAT column with the zero rate.
These three cause most of the rate errors we find, and the reason is structural. All three leave nothing in the VAT column, so the amount payable to HMRC is identical whichever is picked. Nothing looks wrong. Nothing fails. The return files.
What changes is the turnover and purchases the business declares. HMRC's return guidance is explicit that box 6 takes the total value of sales including zero-rated, reduced-rate and exempt supplies, and that box 7 excludes anything that is not consideration for a supply. Zero-rated and exempt amounts belong in those totals. No VAT amounts do not.
So the test is not "was there any VAT on this?" — it is "did somebody supply something?" A postage-only invoice is an exempt supply and belongs in box 7. A salary payment is not a supply and belongs nowhere on the return. Treating the two alike understates declared turnover or purchases, and that understatement never surfaces in the ledger, the profit and loss or the bank reconciliation.
Xero holds reverse charge rates for cases where liability shifts from seller to buyer, and the construction set is not installed by default. It is added in one step from the same Tax rates screen, using the button that loads the domestic reverse charge rates for the 20% and 5% bands on both sides.
The boxes are where this gets mishandled. Under the domestic reverse charge the supplier shows no output tax in box 1 but still reports the net in box 6. The customer enters the output tax in box 1, reclaims the input tax through box 4, puts the net in box 7 — and, per HMRC's notice, must not put that value in box 6. That restriction is specific to the domestic charge and catches out anyone applying habits formed on cross-border services.
The rate is irrelevant if the underlying judgement is wrong. The charge applies only where the customer is VAT-registered and buying for a business purpose, so a supply to an end user is charged normally whatever the dropdown offers. There is a fuller treatment on the VAT reverse charge page.
Importers are the group most likely to have a systematically wrong return, because the import VAT figure cannot be read off the supplier bill. Under postponed accounting the VAT is declared and recovered on the return rather than paid at the frontier, and the amount comes from the monthly postponed import VAT statement HMRC publishes in the customs declaration service.
Xero handles this with a postponed VAT option on the return itself, where the statement figure is entered and reflected in both output and input tax. Freight, duty and clearance charges on the bill are coded on their own merits. Coding the goods value at the standard rate because the goods would be standard-rated domestically is the classic mistake, and it overstates the reclaim. See postponed VAT accounting for the detail.
Xero lets anyone add a rate, which is occasionally necessary and more often a mistake. A custom rate is justified where a genuine reporting need exists that the defaults cannot meet — isolating a reduced-rate category the business analyses separately, or a stream feeding a partial exemption calculation. It is not justified as a renaming exercise, and it should never be a near-duplicate of a rate that already exists.
The cost of a crowded list is paid later, by whoever is coding. Four plausible-looking rates where there should be one means four chances to pick wrongly, repeated across every transaction, by people who will not read the note explaining the distinction. Fewer rates, used properly, beat a precise taxonomy nobody follows.
Migrations create rate errors in bulk, because the person coding is translating from a numbering system they know into names they do not. The mapping below is approximate.
| Sage | Xero equivalent | Watch for |
|---|---|---|
| T1 | 20% on sales or purchases | Straightforward |
| T0 | Zero Rated | Straightforward |
| T2 | Exempt | Often collapsed into Zero Rated on migration — the tax is the same, the analysis is not |
| T5 | 5% on sales or purchases | Straightforward |
| T9 | No VAT | The genuine trap. Sage users accustomed to T9 as a catch-all carry the habit across, and in Xero it removes the amount from the return |
| Import and reverse charge codes | Reverse charge rates, plus the return's postponed VAT option | Xero handles postponed import VAT on the return rather than through a rate, so there is no like-for-like code |
Sage's numbering is configurable in the same way Xero's rates are, so the starting point in both is the system's own list. The Sage VAT codes reference covers the other direction.
A rate can be fixed against a supplier record or an inventory item, and it then overrides whatever the account would have suggested. Useful when deliberate, corrosive when forgotten: bills from one supplier post consistently wrongly, the bookkeeper assumes the account default applied, and the pattern survives several reviews because each transaction looks like a choice somebody made. When one contact's VAT is persistently odd, check the contact record before the transactions.
Here the percentage applied to gross turnover is governed by the scheme setting, not by the rate on each invoice, and input tax is generally not recoverable except on qualifying capital expenditure. Rates still need to be right, because the turnover they feed drives the calculation. But a business that has joined or left the scheme without changing the setting produces a confidently wrong return from perfectly coded transactions.
Once a period is locked or a return filed, the underlying transaction cannot be amended in place and the correction has to go through an adjustment or a later period. People discover this halfway through a clean-up, abandon it, and leave the error to compound. Locking is the right control — it just means rate problems are worth finding before the quarter closes.
This page is general information about how Xero's tax rates behave. It is not advice on the VAT treatment of any particular transaction, which depends on the facts of the supply — where a treatment is genuinely uncertain, get it confirmed before it is repeated a hundred times. We prepare VAT returns, management accounts, year-end accounts and Corporation Tax for owner-managed companies on Xero or Sage. We do not carry out audit work, and specialist tax advice is referred to a specialist firm.
Seven questions, answered from what you already know — no logins and no exports. A straight read on whether the numbers can be relied on, VAT included.
Run the free Books Check → Or read the Sage VAT codes reference