Is the VAT Flat Rate Scheme Right for Your Business?

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Once your business is VAT registered, working out the VAT on every sale and every purchase can take up more time than you expect. The VAT Flat Rate Scheme was designed to make that simpler, and for some small businesses it also saves money. For others, it quietly costs more than standard VAT accounting.

This guide explains how the VAT Flat Rate Scheme works, who can use it, the rules that catch people out and how to decide whether flat rate VAT is right for your business.

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What Is the VAT Flat Rate Scheme?

The VAT Flat Rate Scheme is an HMRC scheme for small VAT-registered businesses. Instead of paying HMRC the difference between the VAT you charge customers and the VAT you pay on purchases, you pay HMRC a fixed percentage of your VAT-inclusive turnover.

That percentage is set by HMRC and depends on your type of business. Your customers will not notice any difference, because you still charge them VAT at the normal rate on your invoices.

In short, flat rate VAT swaps precision for simplicity. You give up the right to reclaim VAT on most purchases, and in return your VAT records and returns become much easier to manage.

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How Does the VAT Flat Rate Scheme Work?

The VAT Flat Rate Scheme works in four steps:

• You charge VAT as normal. Your invoices show VAT at the usual rate, which for most goods and services is 20%
• You add up your VAT-inclusive turnover. This is all the income you received in the period, including the VAT you charged
• You apply your flat rate percentage. Multiply your VAT-inclusive turnover by the percentage HMRC sets for your type of business
• You pay that amount to HMRC. The difference between the VAT you charged and the amount you pay is kept by your business

Any amount you keep is treated as part of your business income, so it is included when you work out your profits for tax.

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A worked example

Imagine a photographer with £20,000 of sales in a quarter (before VAT) and £3,000 of business costs (plus VAT). They charge their clients £4,000 of VAT, so their VAT-inclusive turnover is £24,000. The flat rate for photography is 11%.

In this example, the VAT Flat Rate Scheme saves the business £760 for the quarter. If the photographer had much higher costs, the result could easily be the other way round.

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The first-year discount

If you are in your first year of VAT registration, you get a 1% discount on your flat rate percentage. In the example above, the photographer would pay 10% instead of 11% until the day before the first anniversary of their VAT registration.

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Who Can Join the VAT Flat Rate Scheme?

You can join the VAT Flat Rate Scheme if:

• You are VAT registered
• You expect your VAT taxable turnover to be £150,000 or less (excluding VAT) in the next 12 months

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You cannot use the scheme if:

• You left the scheme in the last 12 months
• You committed a VAT offence, such as VAT evasion, in the last 12 months
• You joined (or were eligible to join) a VAT group in the last 24 months
• You registered for VAT as a business division in the last 24 months
• Your business is closely associated with another business
• You use a margin scheme or the capital goods scheme

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You cannot use the Flat Rate Scheme alongside the Cash Accounting Scheme, although the Flat Rate Scheme has its own cash-based way of working out turnover. You can, however, combine it with the Annual Accounting Scheme.

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When you must leave the scheme

You must leave the VAT Flat Rate Scheme if:

• You are no longer eligible to use it
• On the anniversary of joining, your turnover in the last 12 months was more than £230,000 (including VAT), or you expect it to be in the next 12 months
• You expect your total income in the next 30 days alone to be more than £230,000 (including VAT)

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Flat Rate VAT Percentages

HMRC publishes a list of flat rate VAT percentages for each type of business. You choose the one that best describes your main business activity. Here are some common examples:

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Always check the current list on GOV.UK before you join, and review your category if your business changes.

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The Limited Cost Business Rule

The limited cost business rule is the most important thing to understand before joining the VAT Flat Rate Scheme. Since April 2017, any business that spends very little on goods must use a flat rate of 16.5%, whatever its sector.

You are a limited cost business in a VAT period if your spending on relevant goods (including VAT) is either:

• Less than 2% of your VAT-inclusive turnover, or
• More than 2% of your turnover, but less than £1,000 a year (£250 for a quarterly return)

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Only goods count. The test does not include:

• Services, such as software subscriptions, rent, phone bills or professional fees
• Capital items, such as laptops and equipment
• Food and drink for you or your staff
• Vehicles, vehicle parts and fuel (unless you run a transport business)
• Goods you buy to resell or hire out, unless that is your main business activity
• Promotional items, gifts or donations

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The test applies to each VAT return, so a business close to the threshold can move between its normal rate and 16.5% from one quarter to the next.

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Why the 16.5% rate matters

A flat rate of 16.5% on VAT-inclusive turnover works out at 19.8% of your sales before VAT. In other words, you hand almost all of the VAT you charge to HMRC, and you cannot reclaim VAT on your costs. On £20,000 of sales in a quarter, you would pay £3,960 of the £4,000 you charged and keep just £40.

This rule affects many consultants, contractors, freelancers and other service businesses whose main cost is their own time. For most of them, standard VAT accounting is likely to work out cheaper.

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Pros and Cons of the VAT Flat Rate Scheme

Advantages

• Simpler VAT returns. You do not need to record the VAT on every purchase
• A possible saving. Businesses with few VATable costs that pass the limited cost test can keep part of the VAT they charge
• A first-year discount. You get 1% off your flat rate in your first year of VAT registration
• Capital purchases are still covered. You can usually reclaim VAT separately on a single purchase of capital goods costing £2,000 or more (including VAT)

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Disadvantages

• No VAT reclaim on most purchases. This can be costly if you buy a lot of standard-rated goods or services
• Your flat rate applies to all your income. That includes zero-rated and exempt sales, where you have not charged any VAT
• The limited cost business rule. If you spend little on goods, the 16.5% rate can remove any benefit
• Not suited to repayment businesses. If you normally get money back from HMRC, the scheme will almost certainly cost you more

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Is the VAT Flat Rate Scheme Right for Your Business?

The VAT Flat Rate Scheme may suit you if:

• Your turnover is comfortably under £150,000 (excluding VAT)
• Your VATable costs are low compared with your sales
• You regularly buy enough goods to pass the limited cost business test
• Your sector has a relatively low flat rate
• You value simpler admin over squeezing out every pound

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It is less likely to suit you if:

• You are a limited cost business and would pay 16.5%
• You have high VATable costs, such as stock, materials or equipment
• You make a lot of zero-rated or exempt sales
• You usually receive VAT repayments from HMRC
• Your turnover is growing quickly towards the £230,000 exit threshold

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The most reliable way to decide is to compare the numbers. Work out what you paid under standard VAT accounting over your last few returns, then work out what you would have paid under the Flat Rate Scheme. If the difference is small, the time you save on admin may make the scheme worthwhile. If it is large, the answer is usually clear.

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How to Join or Leave the VAT Flat Rate Scheme

You can join the VAT Flat Rate Scheme online when you register for VAT. If you are already registered, you can apply using form VAT600 FRS. HMRC will confirm you have joined through your VAT online account, or by post if you did not apply online.

You can leave the scheme at any time by writing to HMRC, but you will then have to wait 12 months before you can rejoin. Making Tax Digital for VAT applies whether or not you use the scheme, so you will still need to keep digital records and file your returns using compatible software.

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Why Get Advice Before Joining?

The VAT Flat Rate Scheme can be a useful way to simplify your VAT, but the right answer depends on your sector, your costs and how your business is changing. Joining the wrong scheme, or staying in it after it stops working for you, can mean paying more VAT than you need to.

At Prosper, our VAT services cover everything from choosing the right VAT scheme to preparing and submitting your returns. We will compare your options using your real figures, check whether the limited cost business rule applies and review your position as your business grows.

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VAT Flat Rate Scheme FAQs

How does the VAT Flat Rate Scheme work?

Under the VAT Flat Rate Scheme, you charge your customers VAT as normal but pay HMRC a fixed percentage of your VAT-inclusive turnover. The percentage depends on your type of business. You cannot reclaim VAT on most purchases, apart from single capital purchases of £2,000 or more (including VAT).

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What is the turnover limit for the VAT Flat Rate Scheme?

You can join if you expect your VAT taxable turnover to be £150,000 or less (excluding VAT) in the next 12 months. You must leave if your turnover goes over £230,000 (including VAT) on the anniversary of joining, or if you expect it to.

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What is a limited cost business?

A limited cost business spends less than 2% of its VAT-inclusive turnover on goods, or more than 2% but less than £1,000 a year. Limited cost businesses must use a flat rate of 16.5%, whatever their sector.

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Can I reclaim VAT on purchases under the flat rate scheme?

Generally, no. The flat rate percentage is designed to allow for the VAT you pay on purchases. The main exception is a single purchase of capital goods costing £2,000 or more (including VAT), which you can usually reclaim separately.

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Is flat rate VAT better than standard VAT?

It depends on your business. Flat rate VAT is simpler, and it can save money for businesses with low costs that are not limited cost businesses. Businesses with high VATable costs, zero-rated sales or regular VAT repayments are usually better off with standard VAT accounting.

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Can I leave the VAT Flat Rate Scheme?

Yes. You can leave at any time by writing to HMRC, and you must leave if you are no longer eligible. Once you leave, you cannot rejoin for 12 months.

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Not Sure Which VAT Scheme Is Right for You?

If you are thinking about joining the VAT Flat Rate Scheme, or want to check whether your current scheme still makes sense, get in touch with the Prosper team today. We will run the numbers and help you choose the option that works best for your business.

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