VAT Flat Rate Scheme: everything you need to know

What is the VAT Flat Rate Scheme?

Normally, businesses would subtract the VAT they’ve paid on purchases from the VAT they’ve collected on sales to calculate how much VAT they owe or are owed. The VAT Flat Rate Scheme replaces this calculation, and businesses pay a set percentage of their sales (including the VAT charged to customers) on to HMRC instead.

To join, your business must be VAT-registered and your estimated VAT taxable turnover for the next 12 months must be £150,000 or less. The main benefit of the Flat Rate Scheme for small businesses is that you don’t need to calculate all of the VAT charged and paid for your VAT return. You pay a percentage of your VAT inclusive turnover instead.

Some businesses might find they save money through this scheme, since you get to keep the difference between what you charge customers and what you pay HMRC. It should be noted that businesses on the VAT Flat Rate Scheme can’t claim for VAT on purchases – except for certain capital assets over £2,000.

VAT Flat Rate Scheme vs. standard VAT accounting

The VAT Flat Rate Scheme is less admin-intensive than standard VAT accounting.

With standard VAT accounting, you need to keep records of all the VAT you charge on sales, and all the VAT you pay on purchases. When it comes to generating a VAT return, you subtract the VAT you paid from the VAT you charged to work out what you owe or are owed by HMRC.

Standard VAT accounting requires diligent record keeping. You need to know exactly how much VAT was paid or charged during your VAT accounting period.

In contrast, using the VAT Flat Rate Scheme means you pay the same percentage of your VAT inclusive turnover to HMRC, regardless of what VAT you’ve charged or paid. There are different rates for different businesses, and the right scheme for you will depend on the industry and type of business you run.

For example, if you run an advertising business, the flat rate percentage is 11%. So you would pay HMRC 11% of your VAT inclusive turnover for that period. You don’t need to calculate VAT paid or charged to work out your VAT bill or refund amount.

How does the VAT Flat Rate Scheme work?

Your annual taxable turnover must be £150,000 or less (excluding VAT) to join the Flat Rate Scheme.

HMRC has a list of flat rate percentages based on different industries and businesses. You need to select the one that best fits your business. If you’re in your first year of VAT registration, you get a 1% discount on your flat rate.

Instead of using a calculation to figure out how much VAT you owe/are owed, you pay HMRC the percentage of your VAT-inclusive turnover.

Let’s use the advertising business example again.

Say you have a contract with a customer. You charge them £2000 plus 20% VAT, which equals £2400 in total. You pay HMRC 11% of £2400, which is £264.

If you’re a limited cost business, your flat rate will automatically be 16.5%, regardless of industry. HMRC considers businesses to be ‘limited cost’ if their goods:

• Cost less than 2% of their turnover
• Or cost less than £1000 a year (if costs are more than 2%)

Advantages of the VAT Flat Rate Scheme

The VAT Flat Rate Scheme simplifies bookkeeping for businesses. You don’t need to work out how much VAT you can claim back on purchases, and your payment to HMRC is calculated using the same percentage.

For some businesses, there could even be a cash flow advantage. This is because you can keep the difference between the VAT you charge customers and what you pay HMRC. So if you charge VAT at 20% and have an 11% VAT rate, you could make money from the scheme. However, if the VAT you pay on purchases is significant, you could miss out on claiming it back.

Eligibility for the VAT Flat Rate Scheme

If you’re VAT-registered and you expect your VAT-taxable turnover (excluding VAT) to be £150,000 or less in the next 12 months, you can join the HMRC Flat Rate Scheme.

VAT taxable turnover is the total of everything sold, excluding VAT exempt sales.

There are some exceptions. For example, if you leave the scheme you need to wait at least 12 months before rejoining. Check out the full list of HMRC VAT Flat Rate Scheme exceptions.

Applying for the VAT Flat Rate Scheme

There are multiple ways to join the VAT Flat Rate Scheme. You can join online when you first register for VAT. Or you can fill in the VAT600 FRS and send it:

• Via email

frsapplications.vrs@hmrc.gov.uk

• Via post

BT VAT HM Revenue and Customs BX9 1WR

You need to provide basic business details such as your business name and contact number. Before filling out the VAT600 FRS, make sure you’ve identified the correct flat rate percentage for your business - you’ll need to include this on your application.

VAT Flat Rate Scheme: Important points to consider

There are a few important things to note before you apply for the HMRC Flat Rate Scheme.

1. Flat Rate Scheme percentages apply to most exempt income, as well as zero-rated and reduced-rated supplies. You can see everything you need to include in your flat rate turnover on the HMRC website.
2. Because of this, you might end up paying more VAT on the Flat Rate Scheme if your expenditure on zero-rated and reduced-rated supplies is higher than the industry average.
3. Consider the balance of VAT charged and VAT paid on purchases in your business. High costs might mean that the VAT you can claim back is more valuable than the difference between VAT you charge and what you pay HMRC on the Flat Rate Scheme.
4. You will cease to be eligible for the VAT Flat Rate Scheme if your taxable turnover rises above £230,000 after joining the scheme. If your business is growing fast, this could mean you need to leave the scheme soon after joining it – which impacts your record keeping and VAT return process. In this scenario, standard VAT accounting might be more practical. If you're unsure which would be most beneficial, speak to your accountant.

VAT Flat Rate Scheme FAQs

What is the limit for flat rate VAT?

VAT-registered businesses that expect to earn £150,000 in taxable income or less (excluding VAT) are eligible to apply. Businesses must leave the scheme if their taxable income for the year is more than £230,000.

Is it better to be on a flat rate?

Before you make a call on whether the Flat Rate Scheme is right for you, let’s take a look at the pros and cons.

Pros

• Simplified record keeping for your VAT return
• No complex calculation to work out what you owe / are owed
• Keep the difference between VAT charged to customers and what you pay HMRC

Cons

• You can’t claim VAT back on business purchases
• If your income exceeds £230,000 and you need to leave the scheme, it means a change in how you calculate VAT for your returns
• Some businesses struggle to pinpoint the right industry rate – and HMRC might challenge you on this if you pick the wrong one

How do I deal with record keeping and proof of expenses?

Whether or not you choose to use the VAT Flat Rate Scheme, keeping accurate records is important for any business. And with Making Tax Digital in motion, digital record keeping is fast becoming a regulatory requirement.

HMRC requires that you retain proof of expenses, should they wish to review them. Cloud-based software such as Xero gives you a safe place to record and store these records.