Would you be better off on the VAT Flat Rate Scheme?

Wonder if you'd be better off on the Flat Rate Scheme? Here's an introduction to the UK's VAT Flat Rate Scheme for small businesses.

What is the VAT Flat Rate Scheme and how does it work?

If you use the Flat Rate Scheme, you charge VAT to your customers ("output VAT") and pay VAT to your suppliers when you buy goods or services from them ("input VAT") in the normal way.

But when it comes to preparing your VAT return and paying VAT to HMRC you do things slightly differently. Instead of adding up all the VAT you charge and taking away the VAT you can reclaim, you add up all your sales - including any VAT you charged to your customers - and pay a percentage of those sales to HMRC. The percentage you pay depends on what your business’s trade is, unless you’re a limited cost trader.

Types of sales to include

You need to include any standard-rated, reduced-rated, zero-rated and exempt sales you make in your VAT return. However, you may leave out any sales that are outside the scope of VAT, such as sales of services to businesses in the wider EU.

Claiming back VAT on the Flat Rate Scheme

With the Flat Rate Scheme, you can't claim back any of the VAT you made on purchases, apart from if you buy a capital asset that cost £2,000 or more including VAT.

Percentages of sales on the VAT Flat Rate Scheme

On the Flat Rate Scheme, you pay a percentage of your total sales to HMRC when filing your VAT return. HMRC has set percentages depending on what your business does.

During the first year that your business is registered for VAT (which is not necessarily the same as the first year you're on the VAT Flat Rate Scheme), you get a 1% discount on the percentages - so you would use, for example, 9% instead of 10% for advertising.

Important: if you’re a limited cost trader, you have to use 16.5% instead of your trade’s percentage!

Businesses making more than one kind of sale

If your business fits into more than one category because you make different kinds of sales, you'd choose the percentage that applies to the majority of your sales and apply that to your total sales.

Let's take an example:

A virtual assistant, who is not a limited cost trader, does secretarial work and bookkeeping for their clients.

The flat rate percentage for secretarial services is 11.5%, but for accountancy and bookkeeping it’s 13%.

The virtual assistant adds up their sales for the past year and works out that 70% of their income is from secretarial services and 30% from bookkeeping. As a result, they’ll use the flat rate percentage for secretarial services, which is 11.5%.

VAT Flat Rate Scheme eligibility

If you’re interested in joining the VAT Flat Rate Scheme you can apply to HMRC if your business meets certain criteria.

Your total estimated VATable sales for the next year must be under £150,000 – this includes everything you plan to sell that is subject to VAT.

Once you join the scheme you can keep using it until your total business income goes above £230,000 a year.

You will be ineligible to join the VAT Flat Rate Scheme if:

  • you've been in the scheme before and left it less than 12 months ago (you need to wait until a year has gone by before you can rejoin)
  • you've been guilty of a VAT offence or charged a penalty for evading VAT within the last 12 months
  • you use a second-hand margin scheme
  • you are, or have been within the last 24 months, a member or potential member of a VAT group, or registered for VAT as a division of a larger business
  • your business is closely associated with another business

Benefits of the Flat Rate Scheme

HMRC says the Flat Rate Scheme makes your record-keeping simpler because you don’t have to work out what VAT you can claim on your purchases.

The Flat Rate Scheme can also save you money, though it's not designed with this in mind. This tends to depend on what sector you're in, and how much VAT you pay out on your costs. Check out our VAT Flat Rate Scheme calculator to find out if your business could save money.

When to consider avoiding the Flat Rate Scheme

Because flat rate taxable sales include VAT-exempt sales, it's probably not a good idea to join the scheme if you make a lot of exempt sales - you'd end up paying more in VAT!

If you make a lot of zero-rated sales or if you buy a lot of standard-rated goods and services, joining the scheme is also likely to cost you more in VAT. Businesses not on the Flat Rate Scheme would normally get a repayment from HMRC each quarter which they would lose this if they joined the scheme!

Let’s look at the example of a driver of a diesel-fuelled minibus that seats 12 people.

Diesel is standard-rated for VAT and, because the minibus seats 12 people, the driver’s sales are zero-rated. This means that the input VAT on diesel is 20% and the output VAT on the driver’s sales is zero.

As a result, if the driver is not on the Flat Rate Scheme, they will be able to reclaim VAT on the purchase of diesel each month without having to pay VAT on sales. For example, if the driver earns £5,000 in sales and buys £600 worth of diesel, they will be able to claim back £100 from HMRC in input VAT for that month.

However, on the Flat Rate Scheme the driver would have to pay flat-rate VAT on minibus sales and wouldn’t be able to claim back the input VAT on diesel. So in this example, the driver would have to pay £450 in output VAT (£5,000 x 9% = £450) and wouldn’t be able to claim anything back for the purchase of diesel. The driver would actually be £550 worse off by joining the Flat Rate Scheme.

How can FreeAgent help?

FreeAgent’s digital VAT software supports the Flat Rate Scheme and will calculate all the numbers for you.

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