Dropshipping is an appealing business model because it has low overhead and no inventory to manage. However, the United Kingdom’s value-added tax (VAT) can complicate dropshipping activities. If you don’t handle it correctly, you could pay VAT out of pocket, overcharging customers, or deal with penalties for His Majesty’s Revenue and Customs (HMRC). It’s important to know who needs to register, when to charge the levy, and what’s required for compliance.

Below, we’ll explain how to navigate VAT for UK dropshippers.

What’s in this article?

• How does VAT apply to dropshipping?
  
• What VAT schemes are available for small businesses?
  
• How can dropshippers avoid VAT compliance risks?
  

How does VAT apply to dropshipping?

In the UK, VAT is a tax added to most goods at 20%. If you’re running a dropshipping operation, you might need to gather and pay it to HMRC. There are a few different scenarios that require you to register for VAT and collect it as a dropshipping business in the UK:

• Register for VAT if your taxable turnover exceeds £90,000 in 12 months. Once you hit this limit, you have to register within 30 days of the end of the month in which you hit the threshold.

• You must register for VAT if you’re an overseas seller shipping to UK customers. This is true regardless of your turnover, and you must do so as soon as you start selling.

Registration is optional if your sales are below the threshold and you’re not an overseas seller shipping to UK customers. Some entities register voluntarily to reclaim VAT on expenses, but others stay unregistered to keep their prices lower for shoppers.

Here’s how the levy works for registered dropshipping businesses:

• If you buy from a UK supplier and sell to a UK customer, you apply VAT on your transactions and can recover any VAT you paid to your supplier.

• If you buy from a non-UK supplier and ship to a UK customer, VAT depends on the order value. If the order is £135 or less, you must collect VAT at the point of sale. If the order is over £135, you don’t apply VAT at checkout—instead, import charges are accumulated on delivery, typically by the courier. You cannot reclaim VAT charged in other countries on your UK return.

• If you buy from a UK supplier and sell to those outside the UK, your sales are usually zero-rated. This means you don’t charge VAT but must keep records proving the items left the UK. You can also recover any VAT paid on the purchase of those goods.

What VAT schemes are available for small businesses?

Dropshipping businesses in the UK can choose from several VAT accounting schemes, each with different rules on how VAT is collected, reported, and paid. The right choice depends on your turnover, expenses, and how you prefer to manage cash flow.

Standard VAT accounting

This approach is the default method. Under this scheme, you charge 20% VAT on sales and reclaim it on business expenses based on the invoice date. You typically file a VAT return every quarter and pay HMRC the difference between VAT collected and paid.

Example:

• You collect £200 in VAT from customers

• You pay £50 in VAT to suppliers

• You owe HMRC £150 (the difference)

This method ensures you only pay VAT on your profit margin and allows you to reclaim the tax you pay on expenses, which makes it the go-to choice for many dropshipping businesses.

Flat rate scheme (FRS)

Under this scheme, you pay HMRC a fixed percentage of your gross turnover instead of tracking the levy on each transaction. You still charge customers 20% VAT, but you cannot reclaim it on most purchases (except for certain capital assets). To qualify for this program, your turnover must be under £150,000 per year, excluding VAT.

This option simplifies VAT reporting by requiring fewer calculations and less paperwork, but it’s not ideal if you have high VAT expenses since you cannot recover most of it. The inability to reclaim VAT usually makes this scheme less cost-effective than standard methods for product-based businesses such as dropshipping.

VAT margin scheme

The VAT margin scheme is for sellers of secondhand goods, antiques, art, and similar items. Under this program, the levy is paid exclusively on your profit spread, not the full sale price. You internally calculate 1 ÷ 6 (16.67%) of your profit margin and report that to HMRC instead of adding VAT to the transaction.

Example:

• You buy a used item for £100 and sell it for £200

• Your profit margin is £100, so your VAT is £16.67 (1 ÷ 6 of the spread)

This option does not apply to most dropshippers dealing in new products. But if you resell secondhand goods, it can substantially reduce your VAT payments.

Other schemes, such as Cash Accounting (under which you pay VAT only when you get paid) or Annual Accounting (under which you file VAT once a year), can help cash flow but do not change your VAT owed.

How can dropshippers avoid VAT compliance risks?

VAT compliance is a legal requirement if you’re running a dropshipping business. Missed registrations, incorrect tax rates, or poor recordkeeping can lead to penalties, backdated VAT bills, or operational disruptions. Here’s what you need to keep in mind:

Know when you need to register for VAT

VAT registration depends on where your business is based and where your customers are.

• If you’re a UK-based dropshipper, you must register for VAT when your total VAT-taxable sales exceeds £90,000 in a 12-month rolling period. This resets monthly, so track your revenue carefully. If you hit that threshold, you must sign up within 30 days of the end of the month when you went over or risk penalties.

• If you’re a non-UK business selling to UK customers, you need a UK VAT registration from your first sale—regardless of your expected taxable turnover.

If you miss your sign-up deadline, HMRC can backdate your VAT liability and fine you. That means you’d owe levies on past transactions regardless of whether you charged customers.

Charge the right VAT rate

Once you’re registered, you must correct the percentage for every sale. If you don’t apply VAT when needed, you’ll still owe it to HMRC. If you charge it incorrectly, you could end up over or underpaying, which both cause problems.

• Most goods, but not all, are standard-rated at 20%. Some products qualify for a reduced or zero percentage. If you’re selling a mix of items, ensure you know the correct VAT rate for each one.

• Exports are usually zero-rated, but you must keep proof that the goods left the UK. If you don’t have proof, HMRC can treat the sale as a UK transaction and expect you to pay VAT.

The easiest way to get this right is to keep an updated VAT rate list for everything you sell and review HMRC guidance for clarification.

Keep clean, detailed records

You’ll need to prove that you collected the proper amount of VAT. The better your records are, the easier your VAT returns (or HMRC audits) will be.

• Every sale and purchase must be logged somewhere. Spreadsheets work, but accounting software makes it easier.

• Keep every invoice and receipt for at least six years. If HMRC questions a transaction, you must show them where the numbers came from.

• If you claim VAT relief on exports, hold onto shipping documentation. If you can’t prove a package left the UK, HMRC might say the sale was taxable.

• Properly formatted invoices are key to business-to-business (B2B) sales. Your invoices must contain your VAT number, the exact amount of VAT charged, and full customer details.

Use tech to help with the VAT process

VAT calculations are tedious and easy to get wrong. Automation helps eliminate human error and keeps everything compliant.

• Tools such as Stripe Tax can automatically calculate the right VAT rate for each sale based on customer location and product type.

• Accounting software can sync with your payments system and generate VAT return figures, so you don’t have to track VAT collected versus VAT paid manually.

• Making Tax Digital (MTD) rules mean UK operators must file VAT returns digitally. If you use spreadsheets or paper records, switch to an MTD-compliant system now.

Stay up-to-date on changing VAT rules

VAT rules aren’t static. Businesses need to keep up with shifting thresholds, changing reporting requirements, and new ecommerce regulations—all of which can impact how and when you charge VAT.

• Check HMRC updates regularly. Minor changes can affect your VAT obligations.

• If you’re expanding internationally, understand the VAT rules in your new market. Selling into the European Union, for example, comes with tax obligations that are different from selling domestically.

• If something doesn’t add up, ask an expert. A VAT accountant or tax advisor can help you before a small mistake becomes a big financial problem.