VAT accounting: how to register and choose a scheme

Published Monday 29 June 2026

Table of contents

• What is VAT accounting?
• When should you register for VAT?
• Types of VAT accounting schemes
• Combining VAT schemes
• Choosing the right VAT scheme for your business
• VAT compliance and penalties
• Simplify your VAT accounting with Xero
• FAQs on VAT accounting

Key takeaways

• VAT accounting is how you track, record and report Value Added Tax to HM Revenue and Customs (HMRC). You must register once your taxable turnover exceeds £90,000 over a rolling 12-month period.
• There are four main VAT accounting schemes in the UK. These are Standard VAT accounting, the Cash accounting scheme, the Flat Rate Scheme and the Annual Accounting Scheme.
• Some schemes can be combined. For example, you can combine annual accounting with cash accounting or the Flat Rate Scheme. This reduces both paperwork and cash flow pressure.
• Choosing the right scheme can save you time and improve cash flow. If you're unsure which suits your business, speaking with an accountant is a practical next step.

What is VAT accounting?

VAT accounting is the process of tracking, recording and reporting Value Added Tax on your business transactions to HMRC. Understanding how it works helps you stay compliant and avoid unexpected costs.

Value Added Tax (VAT) is a consumption tax charged on most goods and services sold in the UK. The standard rate is currently 20%. Reduced rates of 5% and 0% apply to certain items such as children's car seats and most food. For a full breakdown, see this guide on what VAT is and how much it costs.

When you sell goods or services, you charge VAT on the sale. This is called output VAT. When you buy goods or services for your business, you pay VAT on those purchases. This is called input VAT.

At the end of each VAT period, you calculate the difference between your output VAT and input VAT. If you've charged more than you've paid, you send the difference to HMRC. If you've paid more than you've charged, you can claim back VAT from HMRC.

Not every business needs to charge VAT. You only need to register if your taxable turnover reaches the registration threshold. Some goods and services are exempt from VAT altogether, including most financial services, education and health services.

When should you register for VAT?

Knowing when to register for VAT is important because missing the deadline can lead to penalties. There are two tests you should be aware of.

The first is the historical test. You must register if your taxable turnover exceeds £90,000 over any rolling 12-month period. The second is the forward-look test. You must also register if you expect your taxable turnover to exceed £90,000 in the next 30 days alone.

Once you've crossed either threshold, you have 30 days to notify HMRC. Your registration will then take effect from the start of the second month after you passed the threshold.

In the year ending March 2024, 41% of VAT-registered businesses had income below the registration limit. That means many businesses choose to register voluntarily. But is it worth it for yours?

Advantages of registering for VAT

Voluntary registration can bring real benefits, especially if your customers are other VAT-registered businesses.

• You can reclaim VAT on business purchases, reducing your costs.
• Your business may appear more established and credible to other businesses.
• You avoid the rush of mandatory registration if you're approaching the threshold.

Learn more about thresholds and timelines in this guide to VAT registration thresholds.

Disadvantages of registering for VAT

Registering also adds responsibilities that you should weigh against the benefits.

• You must charge VAT on your sales, which can increase prices for non-VAT-registered customers.
• You'll need to submit VAT returns to HMRC, usually every quarter.
• You must keep digital records that comply with Making Tax Digital (MTD) requirements.
• You'll face extra admin when tracking and reporting VAT accurately.

Types of VAT accounting schemes

HMRC offers four VAT accounting schemes, each designed to suit different business needs. The scheme you choose affects when you account for VAT, how much you pay and how often you file.

Standard VAT accounting

Standard VAT accounting is the default scheme most businesses use. It follows a straightforward approach based on invoice dates.

Under this scheme, you account for VAT based on invoice dates. This applies regardless of when payment actually arrives. You submit VAT returns to HMRC every quarter, reporting your output and input VAT for that period.

Since April 2022, all VAT-registered businesses must keep digital records and submit returns through MTD-compatible software. This applies whether you're above or below the VAT threshold.

Standard accounting works well if your customers pay promptly and your cash flow is predictable. However, it means you may need to pay VAT to HMRC before your customers have actually paid you.

Cash accounting scheme

The Cash accounting scheme bases VAT on when payments are made and received. Invoice dates don't determine your VAT timing. This can make a real difference to your cash flow.

With cash accounting, you only pay VAT to HMRC once your customer has paid you. Similarly, you can only reclaim VAT on purchases after you've paid your supplier. This gives you more control over the timing of your VAT payments.

Cash accounting also offers built-in protection against bad debts. If a customer never pays an invoice, you won't owe VAT on that sale. Under standard accounting, you'd need to separately reclaim that VAT.

To join the scheme, your estimated VAT-taxable turnover must be £1.35 million or less. You must leave the scheme if your turnover exceeds £1.6 million. You can find full details on the GOV.UK cash accounting scheme page.

Flat Rate Scheme

The Flat Rate Scheme simplifies VAT by letting you pay a fixed percentage of your total turnover to HMRC. You still charge the standard 20% VAT to your customers. The amount you pay over is calculated at a lower, industry-specific flat rate.

The trade-off is that you can't reclaim VAT on most purchases. The only exception is capital assets costing £2,000 or more, including VAT. This means the scheme works best for businesses with low costs of goods.

To join, your VAT-taxable turnover must be £150,000 or less (excluding VAT). You must leave if your total income exceeds £230,000 (including VAT). This threshold has not changed since 2017. If it had increased with inflation, it would be approximately £215,000 in 2026.

New businesses get a 1% discount on their flat rate percentage for the first year of VAT registration. Check whether HMRC classifies you as a limited cost trader. This applies when goods and materials cost less than 2% of turnover or less than £1,000 a year. Limited cost traders pay a flat rate of 16.5%, which removes most of the scheme's benefit.

Read more in the Xero guide to the Flat Rate Scheme or on the GOV.UK Flat Rate Scheme page.

Annual Accounting Scheme

The Annual Accounting Scheme lets you submit just one VAT return per year instead of four. This reduces paperwork and gives you more time to prepare your figures.

During the year, you make quarterly or monthly estimated payments based on your previous year's VAT bill. At the end of the year, you submit a single return and either pay the balance or receive a refund.

To join, your estimated VAT-taxable turnover must be £1.35 million or less. You must leave if your turnover exceeds £1.6 million. Full details are on the GOV.UK Annual Accounting Scheme page.

Combining VAT schemes

You don't always have to choose just one scheme. Some VAT accounting schemes can be used together, giving you the benefits of both.

Annual accounting can be combined with the Cash accounting scheme. You'd make estimated payments through the year and submit one return. You only account for VAT when payments are made or received. This combination is useful if you want less paperwork and better cash flow control.

You can also combine annual accounting with the Flat Rate Scheme. This pairs the simplicity of one return per year with a fixed-percentage VAT calculation.

However, you cannot combine standard VAT accounting with the Cash accounting scheme. You must choose one or the other for how you account for VAT on your invoices. Similarly, you cannot use the Cash accounting scheme and Flat Rate Scheme together.

Choosing the right VAT scheme for your business

The best VAT scheme depends on your business type, turnover and cash flow patterns. Here's a practical way to think through your options.

Standard VAT accounting suits businesses with predictable cash flow and significant purchase costs. If your customers pay promptly and you want to reclaim VAT on all expenses, this is the simplest choice.

Cash accounting is a strong option if you regularly wait for customer payments. It protects your cash flow and shields you from bad debts. It's worth considering if you're a service-based business that invoices before receiving payment.

The Flat Rate Scheme works well for businesses with low material costs, such as consultants or freelancers. Check your industry's flat rate percentage before signing up. Make sure you wouldn't be classified as a limited cost trader.

Annual accounting is ideal if you find quarterly returns stressful or time-consuming. It's especially useful for seasonal businesses with fluctuating income, as you can spread estimated payments evenly through the year.

If you're unsure which scheme fits your situation, speaking with a qualified accountant can help you make a confident decision. You can find a Xero advisor who understands your industry and business size.

VAT compliance and penalties

Staying on top of VAT compliance is essential. Failing to register, file or pay on time can result in financial penalties.

Once your taxable turnover crosses the £90,000 threshold, you're legally required to register for VAT. Continuing to trade without registering can result in backdated VAT charges and penalties.

Since April 2022, all VAT-registered businesses must keep digital records and file returns using MTD-compatible software. Paper records and manual spreadsheet submissions are no longer accepted for VAT.

HMRC uses a points-based penalty system for late VAT returns. You receive one penalty point each time you submit a return late. Once you reach the threshold for your filing frequency, you'll receive a £200 fine.

For quarterly filers, that threshold is 4 points. Points expire after a period of compliant behaviour.

Separate penalties apply for late payments. Interest is charged on outstanding amounts from the day after the due date. Setting up a Direct Debit for VAT payments can help you avoid missing deadlines.

Simplify your VAT accounting with Xero

Managing VAT doesn't have to be complicated. With the right tools, you can track your VAT, keep digital records and file returns directly to HMRC.

Xero Accounting Software supports MTD for VAT and automates calculations. It helps you stay on top of deadlines so you can focus on running your business. Get one month free.

FAQs on VAT accounting

Here are answers to frequently asked questions about VAT accounting.

What is VAT in accounting?

VAT stands for Value Added Tax. It's a consumption tax charged on most goods and services in the UK at a standard rate of 20%. Businesses collect it on behalf of HMRC and can reclaim the VAT they pay on their own purchases.

How does VAT accounting work?

You charge VAT (output VAT) on your sales and pay VAT (input VAT) on your business purchases. At the end of each VAT period, you calculate the difference between the two. You then either pay HMRC or claim a refund.

What is standard accounting for VAT?

Standard VAT accounting means you record VAT based on invoice dates, not payment dates. You submit quarterly returns to HMRC and must use MTD-compatible software to keep digital records and file.

Which VAT scheme is best for small businesses?

It depends on your turnover, cash flow and business type. Cash accounting suits businesses with slow-paying customers. The Flat Rate Scheme benefits those with low purchase costs. An accountant can help you compare the options for your specific situation.

Can you combine different VAT schemes?

Yes, in some cases. You can combine annual accounting with either cash accounting or the Flat Rate Scheme. However, you cannot combine standard accounting with cash accounting, or cash accounting with the Flat Rate Scheme.

What is a limited cost trader?

A limited cost trader is a business on the Flat Rate Scheme with very low goods costs. This applies if your goods and materials cost less than 2% of turnover, or less than £1,000 per year. Limited cost traders must use a flat rate of 16.5%, which significantly reduces the benefit of the scheme.