Would you be better off on the VAT flat rate scheme?
This article was first published on 2 February 2011 and was last updated on 4 January 2018.
By request from one of our great customers, James Ward, here’s an introduction to the UK's VAT flat rate scheme for small businesses.
What is the flat rate scheme, and how does it work?
You’d charge VAT to your customers (“output VAT”) in the normal way, and pay VAT to your suppliers when you buy goods or services from them (“input VAT”), again as normal.
But when it comes to preparing your VAT return and paying VAT to HMRC, instead of adding up all the VAT you charged and taking away from that the VAT you can reclaim, when you’re on the flat rate scheme, you use a different method.
You add up all your sales (including exempt sales but excluding those outside the scope of VAT), including any VAT you charged to your customers, and work out a percentage of those sales – and that’s the VAT you pay to HMRC.
When I add up my sales, do I just include the sales I charge standard-rated VAT on?
You need to include any reduced-rated, zero-rated and exempt sales you make as well - but leave out any sales that are outside the scope of VAT, such as sales of services to businesses in the wider EU.
What about claiming back VAT on goods and services I buy?
You can’t claim back any of the VAT you made on purchases, though, apart from if you buy a capital asset that cost £2,000 or more including VAT.
If you’ve recently registered for VAT (as opposed to joining the flat rate scheme), you can reclaim VAT on stock and assets you bought in the four years before registration and still have, and on the services you incurred in the six months before registration.
What percentage do I use?
HMRC set the percentages depending on what your business does.
In the first year 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.
STOP PRESS!From 1st April 2017, if you are a limited cost trader, you have to use 16.5% instead of your trade’s percentage!
My business makes 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.
Pauline is a Virtual Assistant who does secretarial work and bookkeeping for her clients. She has to buy quite a lot of goods in the form of stationery, so she's not a limited cost trader.
The flat rate percentage for secretarial services is 11.5%, but for accountancy and bookkeeping it’s 13%.
Pauline adds up her sales for the past year and works out that 70% of her income is from secretarial services and 30% from bookkeeping, so she’ll use the flat rate percentage for secretarial services: 11.5%.
Can anyone use the scheme?
You can’t just start using the scheme. You have to apply to HMRC if you want to join.
Your total estimated VAT taxable sales, that is everything you plan to sell that is subject to VAT (including zero-rated sales but excluding exempt sales, sales outside the scope of VAT, and sales of capital assets), for the next year, must be under £150,000 excluding VAT.
But once you join the scheme you can keep using it until your total business income goes above £230,000 a year.
Some businesses can’t join the scheme.
If you’ve been in the scheme before and left it less than 12 months ago, you can’t rejoin. You need to wait until a year has gone by before you rejoin.
And HMRC won’t let you join the scheme if you’ve been guilty of a VAT offence or charged a penalty for evading VAT within the last 12 months.
Users of second-hand margin schemes can’t use the flat rate scheme.
And if 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, you can’t join.
You also can’t join if your business is closely associated with another business.
Why would I want to join the scheme?
HMRC say it makes your record-keeping simpler because you don’t have to work out what VAT you can claim on your purchases – and, because there are a lot of potential pitfalls in this area, I would agree with them.
It 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.
When would it not help me to join the scheme?
Because your flat rate taxable sales includes exempt sales, it’s probably not a good idea to join the scheme if you make a lot of exempt sales – you’d pay more in VAT.
For example, a funeral director would be very ill-advised to join the flat rate scheme, because burial of the dead is exempt from VAT.
If you make a lot of zero-rated sales, and/or if you also buy in a lot of standard-rated goods and services, it’s also likely to cost you more in VAT if you join the scheme. In this situation, by not using the flat rate scheme you would usually get a repayment from HMRC each quarter, which you won’t want to lose!
Let’s take another example.
Mark is a minibus driver. His minibus seats 12 people so his sales are zero-rated.
When he buys diesel for his minibus, that is standard-rated for VAT, so Mark receives a repayment from HMRC most quarters, because the output VAT on his sales is 0, but he can claim input VAT on the diesel he buys.
For January 2017, Mark earned £5,000 in sales, and bought £600 worth of diesel, so he could claim £100 back from HMRC in input VAT.
If Mark joined the flat rate scheme, he would have to pay flat rate VAT on his sales, and wouldn’t be able to claim the input VAT on his diesel. So he would have to pay VAT of £5,000 x 9% = £450.
Mark would be £550 worse off by joining the flat rate scheme!
So it’s worth crunching some numbers before you apply to join, because it could save you money but it could also cost you money, depending on your business!
How can FreeAgent help me?
If you set your FreeAgent account to flat rate VAT it will calculate all the numbers for you.
Disclaimer: This article is no substitute for advice from an accountant tailored to your own business situation.
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