What Is the Flat Rate VAT Scheme?

The Flat Rate Scheme for Value Added Tax (VAT) lets eligible businesses pay HM Revenue and Customs (HMRC) a fixed percentage of their VAT-inclusive turnover, instead of working out VAT on sales minus the VAT they can reclaim on purchases. It's a simpler calculation, and for some businesses it's a cheaper one too.

Whether yours is one of them comes down to your sector rate, your expenses and the limited cost trader rules. At TurnerBerry, our VAT accountants run those figures with businesses in Bristol, Cardiff and across the UK before they choose a scheme, and we keep checking them throughout the year as spending changes.

Key Takeaways

• You can apply if your expected VAT taxable turnover is £150,000 or less, excluding VAT, over the next 12 months.
• Your flat rate normally depends on your trade sector and applies to VAT-inclusive turnover.
• Limited cost traders use 16.5%, which can leave little financial benefit.
• The first-year discount reduces your flat rate by one percentage point until the first anniversary of VAT registration.
• You cannot normally reclaim VAT on routine purchases, although certain capital goods qualify.
• The £230,000 leaving threshold has specific review and timing rules. Crossing it does not always mean leaving that day.

Flat Rate VAT Scheme Explained

The scheme changes how you work out the VAT you pay HMRC. What you charge customers stays the same.

Say you invoice a client £1,000 plus £200 VAT. Under standard VAT accounting, you'd pay HMRC that £200 less any eligible VAT reclaimed on business purchases. Under the Flat Rate Scheme, you apply your flat rate percentage to the full £1,200.

Your invoices still show the normal standard, reduced or zero rate where it applies. Customers never see or pay your flat rate percentage.

Each sector percentage has an allowance for business expenses built in. It doesn't move with what you actually spend, so two businesses in the same sector can end up with very different results on the scheme.

Who Can Use the Flat Rate Scheme?

Sole traders, partnerships and limited companies can all apply, because business structure isn't part of the test.

You need to be VAT registered, or registering, and expect your VAT taxable turnover to be £150,000 or less, excluding VAT, over the next 12 months. HMRC wants a forward-looking estimate, though your previous trading figures are usually the best place to start. Exempt sales aren't included in VAT taxable turnover.

Some businesses are excluded. You can't rejoin within 12 months of leaving, and restrictions apply if you're registered in divisions, have been in a VAT group recently or are closely associated with another business.

You still need to keep digital VAT records and file through Making Tax Digital (MTD) compatible software, including the purchase records behind your limited cost trader test.

Flat Rate Percentages and Turnover Limits

HMRC publishes a percentage for each trade sector. Pick the category that best describes what your business does, even if a neighbouring one has a lower rate.

This is a selection from the HMRC flat rate list. In construction, the split between general and labour-only services depends on the value of materials you supply, so check the category definition as well as the percentage. If you also work under the Construction Industry Scheme, our CIS returns team can check how both sets of rules apply to you.

The joining and leaving limits measure turnover differently, and only the leaving test includes VAT. We cover when that test applies further down.

Understanding Limited Cost Traders

A consultancy can spend heavily on software, professional fees and phone contracts and still buy very few goods. Services don't count as relevant goods for this test, so all that spending won't get you out of it.

You're a limited cost trader if your VAT-inclusive spending on relevant goods is:

• Less than 2% of your VAT-inclusive turnover for the accounting period; or
• Above 2% but below £1,000 a year, adjusted for the period. For a normal quarter, that is £250.

Spending that doesn't count includes:

• Services, such as software subscriptions and accountancy fees.
• Capital expenditure goods, such as business equipment.
• Food and drink for you or your staff.
• Vehicles, vehicle parts and fuel, except where the relevant transport business exception applies.

If the test catches you, you use 16.5% instead of your sector percentage. Your status can change from one VAT accounting period to the next, so check it every period.

Take a quarter with £25,000 of standard-rated sales plus £5,000 VAT. Your VAT-inclusive turnover is £30,000, and 2% of that is £600. Spend less than £600 on relevant goods and you're inside the limited cost test.

At 16.5%, your flat rate payment is £4,950. That leaves £50 of the VAT you collected, before you count the VAT you can't reclaim on expenses.

Now add £200 of VAT paid on services that you could otherwise have reclaimed. Standard VAT accounting gives a £4,800 liability, so the Flat Rate Scheme costs £150 more. That's why we check the limited cost test first for service businesses, before we look at the sector rate at all.

First-Year Discount on Flat Rate Percentage

In your first year of VAT registration, your flat rate drops by one percentage point, so a 12% rate becomes 11%.

The clock starts on your VAT registration date, not the day you join the Flat Rate Scheme. Join six months after registering and you get roughly six months of discount.

When we compare schemes for clients, we run the numbers on the full rate as well as the discounted year, because the full rate is what you'll be paying from year two.

How to Calculate and Pay VAT Under the Scheme

Under the basic turnover method, you take your VAT-inclusive turnover for the accounting period and multiply it by your flat rate.

That turnover includes standard-rated and reduced-rated sales with their VAT, plus all zero-rated and exempt income. Your flat rate applies to those too, so if a large share of your income is zero-rated or exempt, the scheme can cost you more than standard accounting.

For example, £30,000 of VAT-inclusive turnover at a 12% rate gives a £3,600 payment to HMRC. Always use the gross figure. Applying 12% to the £25,000 of net sales would give £3,000 and understate what you owe by £600.

Input Tax and Expense Claims

Input tax is the VAT you pay on business purchases. On the Flat Rate Scheme you can't normally reclaim it on routine costs like software subscriptions, stock, fuel, subcontractors or accountancy fees.

Keep the records anyway. You still need them for your business accounts, your Corporation Tax or Self Assessment return and the relevant goods calculation.

Reclaiming VAT on Capital Asset Purchases

Certain capital expenditure goods are still eligible for VAT recovery when a single purchase costs £2,000 or more including VAT. They have to be bought in one purchase from one supplier and meet the normal recovery conditions. Goods bought for resale, leasing or consumption in the business don't qualify.

A laptop and monitor bought together for £2,400 including VAT may qualify. Buy them separately, each under £2,000, and neither purchase meets the threshold, so plan the order before you buy.

Flat Rate Scheme vs Standard VAT

Put the same sales and purchases through both methods and see which one costs your business less VAT.

Businesses that buy a lot of stock, materials, equipment or VAT-bearing subcontract labour reclaim significant input tax under standard accounting. If that reclaim is bigger than the gap between the VAT you charge customers and the flat rate payment, standard accounting is cheaper.

If your costs are mostly wages, insurance and other spending with little or no VAT on it, there's less to reclaim. A good sector rate can work in your favour there, as long as the limited cost trader rules don't replace it.

Compare your previous four quarters before joining, and allow for planned purchases, changes in turnover and the end of any first-year discount. Then review the decision every year and whenever your spending changes.

When to Leave and What Happens If You Exceed the Limit

You have two main turnover tests to watch, and you can also leave voluntarily:

• Anniversary test: check your total income, including VAT but excluding sales of capital assets, for the year ending on your scheme anniversary. If it exceeds £230,000, a business filing quarterly normally leaves at the end of the VAT period containing that anniversary.
• Next-30-days test: if you reasonably expect income to exceed £230,000 in the next 30 days alone, excluding capital asset sales, you must leave from the beginning of that 30-day period.
• Voluntary departure: you can leave at any time, including when higher expenses make standard VAT accounting cheaper. Leaving at the end of a VAT period usually makes the change easier to manage.

If an annual increase came from unexpected, one-off business activity, HMRC may let you stay on the scheme when it's satisfied your income over the next 12 months won't exceed £191,500. You need to apply in writing and get HMRC's agreement.

Tell HMRC you're leaving and HMRC will confirm your leaving date. Standard VAT accounting applies from then, and if the date falls mid-period, your return has to account for both methods. You then have to wait 12 months before rejoining.

How to Join the Flat Rate Scheme

You can choose the scheme when you register for VAT. If you're already registered, apply online or by post using form VAT600FRS.

Have your business details, VAT registration number, turnover estimate and chosen trade sector ready, and check whether the limited cost trader rules would change your rate. Starting at the beginning of a VAT period means you won't have to split a return between two methods. Check the start date HMRC confirms before you begin using the scheme.

Find Out Which VAT Scheme Saves You More

The Flat Rate Scheme can save you money, or quietly cost you more every quarter. The only way to know is to run your own figures through both methods.

We'll compare the Flat Rate Scheme with standard VAT accounting using your real sales and purchases, check the limited cost trader test, and tell you which option leaves more money in your business. If you switch, we handle the application, set up your software and file your returns every quarter.

Book a call with our team, or get an instant quote for fixed-fee VAT support.