Mention “VAT” to any business owner and the response is likely to be a barely suppressed groan.
Usually, the filing of quarterly VAT returns is yet another administrative headache that they could do without.
But VAT is an inescapable part of being in business for all but the smallest organisations.
That’s why you should consider whether you could make your life a little easier by applying to join the VAT Flat Rate Scheme.
Read this article to learn what VAT is, find out about the VAT Flat Rate Scheme and discover if your business is eligible for it.
It will also cover:
- The flat rate VAT threshold
- Pros and cons of the VAT Flat Rate Scheme
- Flat rate VAT rates
- Details on how to register for flat rate VAT.
What is VAT?
VAT (value-added tax) is a tax levied on the sales of goods and services.
It was first introduced in the UK in 1973. VAT-registered businesses charge VAT at a rate of 20% on the goods and services that they provide to their customers.
The taxable turnover threshold that determines whether a business must be registered for VAT is currently £85,000.
Nevertheless, businesses with a lower turnover can voluntarily apply for VAT registration if they believe it is in their best interest to do so, perhaps because they would benefit from being able to reclaim VAT on large expenses.
VAT Flat Rate Scheme explained
The HMRC VAT Flat Rate Scheme for small businesses, including small limited companies, has existed since the 2002 Budget.
It was introduced to relieve small business owners of some of the administrative burden involved with preparing VAT returns.
Until 2017, the VAT Flat Rate Scheme was also a good way for small businesses to boost their profits, since the flat rate of VAT that they paid to HMRC on their sales was often considerably lower than the headline VAT rate they charged their clients, allowing them to pocket some of the difference.
This advantage was significantly reduced with effect from 1 April 2017 when the UK government decided to crack down on what it considered to be aggressive abuse of the VAT Flat Rate Scheme.
Specifically, it introduced a higher flat rate of 16.5% for businesses considered to be “limited cost” traders.
A limited cost trader is defined as one whose VAT-inclusive expenditure on goods is either less than 2% of their VAT-inclusive turnover in a prescribed accounting period, or greater than 2% of their VAT-inclusive turnover, but less than £1,000 per annum.
Is my business eligible for the VAT Flat Rate Scheme?
You have to leave the flat rate tax scheme if, on the anniversary of joining, your turnover in the past 12 months was more than £230,000 (including VAT) or if you expect it to be in the coming 12 months.
Alternatively, your business may wish to cancel its VAT registration if your turnover (excluding VAT) falls below £83,000.
The introduction of the 16.5% higher flat rate in 2017 may have reduced some of the attractiveness of the VAT Flat Rate Scheme to small businesses.
However, it is still important that you carefully consider whether it would be better for you to sign up for the scheme rather than the Standard VAT Accounting Scheme if you either want, or need, to become VAT-registered.
Standard VAT Accounting Scheme vs VAT Flat Rate Scheme
With the Standard VAT Accounting Scheme, your business must pay the 20% tax that it charged on eligible sales in the previous quarter to HMRC.
Yet you can also reclaim the VAT that you make on your purchases.
As a result, the amount of VAT that your business pays or claims back from HMRC is usually the difference between the VAT charged by your business to its customers and the VAT that your business pays on its own purchases.
With the VAT Flat Rate Scheme, your business pays a fixed rate of VAT to HMRC and can keep the difference between what you charge your customers and what you pay to HMRC.
You can’t reclaim VAT on your purchases, however, except for certain capital assets costing more than £2,000.
Although limited cost businesses are restricted to a higher fixed rate of 16.5%, those businesses that do not fall into the limited cost category can apply fixed VAT flat rates ranging from 4% to 14.5% to their gross turnover, including VAT, depending on the business sector or type.
An advertising agency would apply a fixed VAT flat rate of 11%, for example, with that figure falling to 9% for a textile manufacturer.
There are a number of other VAT schemes, such as the cash accounting scheme, that might be worth exploring too.
Read more about VAT
- How to register for VAT online: A straightforward guide
- What is VAT? UK VAT basics
- How to understand and manage VAT for your business
- Small business guide to VAT
- Making Tax Digital for VAT: What do HMRC’s updates mean for you?
- How to submit a Making Tax Digital for VAT return
Pros and cons of the VAT Flat Rate Scheme
Simon Dolan, founder of Dolan Accountancy, believes the HMRC Flat Rate Scheme continues to offer the benefits of less administration for business owners and a potential boost to profits.
Once you know how to complete the online form, accounting for flat rate VAT is a fairly straightforward process since filling in a flat rate VAT return is usually easier than filling in a standard rate VAT return.
“You will only need to tell HMRC how much you have charged in VAT in total,” he says.
“There is no need to reconcile your receipts. There is also the opportunity to earn money from the flat rate scheme.
“For example, if you charge 20% VAT and you pay a flat rate percentage of 16.5% on gross sales, you keep the difference.
“In addition, if you are a new business, you can benefit from an extra 1% discount in your first year of trading.”
The main disadvantage of the VAT Flat Rate Scheme, compared with the Standard VAT Accounting Scheme, is that a business cannot reclaim VAT on its purchases.
“Depending on your business, if you buy stock or you have a high amount of VATable expenses, you cannot get the VAT back,” Simon explains.
Wondering whether the VAT Flat Rate Scheme is the best option for your business?
Simon advises you to calculate whether the amount of VAT you could reclaim from your monthly expenses would outweigh the discount you get from participating in the scheme.
Graham Elliott, is the director of City & Cambridge Consultancy. He says one potential pitfall for businesses that use the VAT Flat Rate Scheme is most of a company’s “exempt” income – income it might earn from leasing out commercial land or property, for example – is taxed on the flat rate, with bank account interest being a notable exception.
“Most exempt income is taxed on the flat rate, which is a major trap,” he says. “In fact, this also applies to zero-rated and reduced-rated supplies.”
Another challenge for some businesses is identifying the correct VAT flat rate, based on their business type. This is because it is not always clear what trade class a business falls into.
“For many, the trade class is easy,” says Graham. “But, for some, it is difficult because the classification is geared towards simple, mainstream trades.
“HMRC refuses to decide on the scheme user’s behalf but can challenge the choice that the scheme user makes.”
Zoe Gibbons, a consultant at Perrys Chartered Accountants, also points out that the likely growth rate of your business should be taken into account.
If the revenue of your business was likely to fast exceed the upper limit of £230,000, you would soon have to leave the Flat Rate Scheme anyway.
She says: “Your business should consider its business plan and forecast turnover figures because if it is expecting to grow quickly, it may be more beneficial to set up under the standard scheme initially to get into good practice.”
The subtleties involved mean that choosing the VAT Flat Rate Scheme above the Standard VAT Accounting Scheme is not necessarily a straightforward taxation decision.
For this reason, Zoe believes you should discuss their options with your accountant if you have one.
She says: “As each business is different, and will have a different set of circumstances, and VATable outputs and inputs, it is important to speak to your accountant to confirm which scheme would be most beneficial for the business, both from an administrative and a tax point of view.”
How to register for the VAT Flat Rate Scheme
Your business needs to be registered for VAT in order to join the VAT Flat Rate Scheme. It is possible to apply by post, phone or email but the easiest way is probably to fill in the online application form VAT600FRS.
To fill in the form, you’ll need to following information:
- Business name
- Business address (you just need to highlight whether it’s located in the UK or not)
- Telephone number
- VAT registration number
- Details on your main business activity
- The flat rate percentage you’ll use
- The date you’d like to start using the VAT Flat Rate Scheme (HMRC will notify you of the date but you can opt for another date if necessary – you’ll have to highlight the reason for your new date)
To apply by post, you will need to download the form, fill it in and send it to the National Registration Service at: HM Revenue & Customs, National Registration Unit, Imperial House, 77 Victoria Street, Grimsby, DN31 1DB.
For phone applications, contact the HMRC VAT Helpline on 0300 200 3700. Email applications can be made by sending a completed VAT600FRS form to [email protected]
Final thoughts on the VAT Flat Rate Scheme
Ultimately, the question of whether the VAT Flat Rate Scheme is right for your business will depend on:
- What your company does (that will determine the flat rate VAT sector and flat rate VAT tax rate that apply)
- What kinds of VATable outputs and inputs the business has
- How quickly its revenues might surpass the flat rate VAT limit
- Whether it earns “exempt income”.
If you have access to an accountant, they will be able to help you make the decision that is most appropriate for your business circumstances.
Small business guide to VAT
Managing VAT can be a pain for many small businesses - but it doesn't have to be! Everything you need to register and submit VAT and staying compliant is right here.