Millward, May & Co - Wokingham Accountants
Wokingham Accountants

VAT Flat Rate Scheme

Flat Rate

What is the flat rate VAT scheme and should you be on it?

Normal Scheme

Normally the amount of VAT a VAT-registered business pays or reclaims from HMRC is the difference between the VAT charged on sales invoices to customers and the VAT on their business purchases or expenses.

As an example:

  • You invoice a customer £12,000 (£10,000 + £2,000 VAT) and have VATable business expenses of £600 (£500 + £100 VAT).

  • Therefore you owe HMRC £2,000 in VAT (£10,000 x 20%) but can reclaim £100 in VAT (£500 x 20%).

  • On your next VAT return, you will pay HMRC £1,900 in VAT (£2,000 - £100)

Flat Rate Scheme

Under the flat rate scheme you pay a fixed rate of VAT (according to your industry) on your VAT-inclusive sales and you cannot reclaim VAT on your purchases (except for certain capital assets over £2,000).

If we assume that the industry percentage for the example above is 14.5% you will pay VAT of £1,740 (£12,000*14.5%).

This is £160 less than our normal scheme example above (£1,900-£1,740).

Limited Cost Trader

As you can see from the example above, some businesses used to be able to pay over less VAT than they were collecting. Contractors with minimal VATable expenses could actually make money from the scheme. Therefore, in April 2017, HMRC introduced the concept of a “limited cost business”.

What is a “limited cost business”?

You are classed as a limited cost business if your goods cost less than either:

  • 2% of your turnover

  • £1,000 a year

The definition of goods is the thing that catches most businesses out - they have to be movable items or materials exclusively used in your business. You cannot include:

  • Any services e.g. accountancy services

  • Expenses e.g. travel, accommodation

  • Vehicle costs unless you are a transport business

  • Rent, internet, phone bills

  • Gifts, donations

  • Training, memberships

  • Capital items (e.g. laptops)

As you can see, this would mean that almost all contractors would fall into this classification as they are not selling goods but rather providing a service and so would not be spending money on goods or materials.

How much VAT do I pay as a limited cost trader on the flat rate scheme?

As a limited cost business, the flat rate VAT percentage is set at 16.5%, however you get a 1% discount in your first year.

If we take the previous example for your first year of trading:

  • You will pay VAT of £1,860 (£12,000*15.5%)

  • This is £40 less than under the normal scheme (£1,900-£1,860)

After your first year the percentage increases to 16.5% and therefore:

  • You will pay VAT of £1,980 (£12,000*16.5%)

  • This is £80 more than under the normal scheme (£1,900-£1,980)

Therefore in this case, it would be beneficial to move onto the normal scheme after your first year on the flat rate scheme.

Each situation is different- It will depend on how many VATable purchases you make and the level of your sales. We would advise checking your situation with us before deciding which scheme to go on.

Other considerations

Administration – the flat rate scheme VAT returns are easier to compile and submit than under the normal VAT scheme. However, the accounting software available makes it fairly easy now. We have a number of tutorials on how to do this shown on the link below.

Eligibility – to join the flat rate scheme, your VAT turnover must be £150,000 or less

Capital purchases – on the flat rate scheme you can still reclaim VAT on capital assets (e.g. laptop) over £2,000.

Leaving the scheme - you can leave the scheme at any time. You must leave if on the anniversary of joining, your turnover in the last 12 months was more than £230,000 (including VAT). In order to leave, you have to write to HMRC stating your leaving date.

Useful links