How Does the Flat Rate VAT Scheme Work?

The Flat Rate VAT Scheme is one of HMRC’s VAT schemes available to help to simplify VAT reporting for certain smaller businesses and ease cash flow.

In this guide, I’ll explain how the flat rate VAT scheme works, registration, who qualifies to use it and how some registered businesses are affected by what is known as the Limited Cost Trader guidelines, which restricts the flat rate percentage they can use.

Updated 14 July 2021

1. What is the VAT Flat Rate Scheme?

Businesses registered for VAT under the traditional scheme must charge VAT at the applicable VAT rate for their trade, usually 20% and claim back VAT on expenses. Usually quarterly, a business will declare all its sales and purchases for 3 months and pay the difference to HMRC, or receive a repayment if they’ve paid more VAT than they’ve collected.

Confused by VAT? Read this guide to VAT and How it Works >>

The flat rate VAT scheme helps to simplify VAT as well as helping them to avoid the costs of accounting fees, errors and save business administration time. Under the rules of the VAT flat rate scheme businesses:

1. Pay a fixed percentage rate of VAT to HMRC, according to their business types, on its sales based on the VAT inclusive amount billed to their customers;
2. Keep the difference between the VAT charged to customers and actually paid to HMRC;
3. Cannot claim the VAT back on any of purchases, except for certain capital assets over £2,000.

2. An Example of the Flat Rate VAT Scheme

Jane is an IT consultant and has an estimated turnover of £120,000 for the next 12 months. She is eligible to use the VAT Flat Rate Scheme.  Jane looks up the applicable flat rate fixed percentage for her business and it is 14.5%.

Every time Jane raises an invoice to one of her clients she must add 20% VAT onto this invoice so her client isn’t aware she is registered for the scheme.  But, when Jane fills out her flat rate VAT return to HMRC, she will apply her fixed percentage of 14.5% to her net sales.

Let’s say that Jane has billed a total of £10,000 plus VAT during one quarter, she will have collected £2,000 (£10,000 x 20%) from her clients. She will pay HMRC £1,740 (£12,000 x 14.5%). That means she ‘profits’ £260 in this quarter.

But this isn’t really profiting as such. Jane may have paid for VATable expenses during the quarter on which she’s unable to claim back the VAT she paid. The VAT rate percentage is set at an appropriate level HMRC considers fair, to cover any input VAT she pays – so the £260 ‘profit’ represents a contribution towards this.

3. Who Can Register for the VAT Flat Rate Scheme?

Businesses with a taxable turnover of less than £150,000 are eligible to join the VAT Flat Rate Scheme.

Taxable turnover means the value of sales that would be relevant for charging the standard rate of VAT (20%), excluding any sales that would be exempt from VAT (such as insurance or some financial services).

You cannot join the VAT flat rate scheme if you:

• left the scheme in the last 12 months;
• committed a VAT offence in the last 12 months, eg VAT evasion;
• joined (or were eligible to join) a VAT group in the last 24 months;
• registered for VAT as a business division in the last 24 months;
• your business is closely associated with another business;
• you’ve joined a margin scheme or capital goods VAT scheme.

4. VAT Flat Rate Percentages

HMRC sets out the percentage businesses should use instead of the standard VAT rate of 20%. You can check for the VAT Flat Rate Percentages here but here are some examples:

Accountancy or bookkeeping	14.5%
Boarding or care of animals	12%
Computer and IT consultancy or data processing	14.5%

Some VAT flat rate percentages have been reduced in line with the Hospitality and Tourism VAT cut, these include hotels, pubs and catering services.

5. 1% Flat Rate Discount

Certain businesses who are new to the Flat Rate Scheme are eligible for an additional 1% discount on their flat rate percentage. So if your flat rate percentage is 12%, for the first year of your registration in the scheme you may be able to use a rate of 11% instead.

6. Claiming VAT Back on Capital Assets Over £2,000

If you use the flat rate scheme then you can claim back VAT on capital expenditure where the purchase price is £2,000 or more including VAT. These purchases will be included in box 4 of your flat rate VAT return. For the VAT reclaim to be eligible, the purchase must be:

• A single purchase of £2,000 or more, although you could buy multiple items from the same supplier at the same time and the purchase would still be eligible;
• Related to goods such as a computer and printer not services or software;
• Capital expenditure not purchased with the intention of generating income for example a van purchased for business use during the week but rented out over the weekend;
• A van bought on hire purchase (but not one hired under a continuous lease).

You do not need to apportion the cost of any item used personally for the purposes of claiming back VAT on capital assets over £2,000 – this helps simplify the reporting system for flat rate VAT.

Where input tax has been claimed on a capital asset, which is then subsequently sold, VAT must be accounted for at the rate of the sale, not the flat rate percentage. Even if you have chosen not to claim back the VAT on the purchase of an asset, you must still include the sale as part of your flat rate VAT return.

7. HMRC Limited Cost Trader

Since some traders were getting a competitive advantage by making money from the scheme, HMRC introduced new guidelines from 1 April 2017 called Limited Cost Traders. Any business that falls under the rules of Limited Cost Traders will have their flat rate percentage set at 16.5%, regardless of their industry percentage.

A limited cost trader is a business that:

• spends less than 2% on goods, but not services, of its VAT inclusive turnover during an accounting period or;
• spends less than £1,000 a year will be immediately considered a Limit Cost Trader, even if this is more than 2% of its turnover.

When working out if you spend more than £1,000 a year on purchases remember to EXCLUDE the following from your costs:

• The cost capital purchases (like a new computer)
• Food, drink and entertainment (like lunches for staff)
• Vehicles costs
• Any non physical services such as accounting fees or software

These exclusions are part of the test to prevent traders from buying either low-value everyday items or one-off purchases in order to inflate their costs beyond 2%.

8. Advantages of the VAT Flat Rate Scheme

The advantages of the VAT Flat Rate Scheme include:

• Simplified VAT reporting and record keeping;
• A business registering for the first time may be eligible for an additional 1% reduction of their flat rate percentage for one year;
• Potentially making money from using a lower rate of VAT than the standard rate, subject to the Limited Cost Trader rules;
• Combining the flat rate scheme with the annual accounting scheme can help reduce your VAT administration further;
• Combining the flat rate scheme with the cash accounting scheme can be beneficial for cash flow.

The VAT Flat Rate Scheme may not work for everyone and there is no legal requirement to join the scheme. 

9. Disadvantages of the VAT Flat Rate Scheme

Joining the flat rate VAT scheme may NOT be suitable if:

• You are expecting VAT repayments for example, if you are a startup and need to incur costs which have VAT on them;
• You’re expecting to have regular input tax to claim above the ‘profit’ you will make.

10. How to Register for the VAT Flat Rate Scheme

You can register for the VAT flat rate scheme online, by email or by post. The method you choose to use will depend partly on whether you are already registered for VAT or not.

10.1. Online

If you are already VAT registered then the simplest way to register for the flat rate scheme is online using at VAT600 FRS form.

If you are not currently registered for VAT, then you’ll need to register for VAT separately first, then apply to join the flat rate scheme.

10.2 By Email

If you are already VAT registered then you can register for the flat rate scheme online using a VAT600 FRS form and then email your application to frsapplications.vrs@hmrc.gsi.gov.uk

If you are not currently registered for VAT, then you’ll need to register for VAT separately first, then apply to join the flat rate scheme.

10.3 By Post

If you are already VAT registered, then you can join the flat rate scheme by post. You need to complete a VAT 600 FRS Flat Rate Scheme form.  This can be completed online then printed and posted to HMRC at:

HM Revenue and Customs – Annual Accounting Registration Unit 
Imperial House 
77 Victoria Street 
Grimsby 
DN31 1DB 
United Kingdom

If you are not currently registered for VAT, then you’ll need to register for VAT separately first, then apply to join the flat rate scheme.

11. Flat Rate VAT Returns and Making Tax Digital

In recent years, HMRC has taken steps to begin digitising the entire tax system (known as Making Tax Digital) which includes submission of VAT returns using approved bookkeeping software. Instead of filling out a manual VAT return with total figures, VAT registered businesses must maintain their bookkeeping electronically so that the software calculates the figures that go onto each VAT return and submits them electronically to HMRC.

This means if you are VAT registered, whether under the flat rate scheme, standard scheme or any other scheme, you’ll need to do your bookkeeping on an HMRC approved software. Then when you’re ready to submit your flat rate VAT return, you’ll do that through your cloud-based system.

It is important you choose a bookkeeping software that can handle the flat rate VAT scheme such as Quickbooks or Xero. If you are using one that doesn’t handle different VAT schemes, then HMRC does permit you to make an adjustment to your return before submitting it. But this can get complicated, so it is advisable to choose one that is compatible with the flat rate VAT scheme so everything gets calculated on your behalf.

12. Record-Keeping for the Flat Rate Scheme

When you’re part of the flat rate scheme, you’ll need to keep some additional VAT records. As with any VAT scheme, you must keep records and details of all returns you have submitted and your workings but you’ll also need to keep a record of:

• the flat rate percentage you have used each quarter;
• breakdown of how you calculated the amount of VAT due or repayable;
• breakdown of your flat rate turnover used for calculating each VAT return;
• any amounts you have spent on capital asset purchases if you wish to claim back VAT;
• Copies of VAT invoices you have sent to your customers/clients detailing VAT charged at the standard rate;
• Bank statements.

13. Bad Debt Relief and the VAT Flat Rate Scheme

If you are part of the flat rate scheme and are in the unfortunate position of not being paid by a customer or client, then you may be able to claim for bad debt relief, including a contribution towards any purchase VAT you may have incurred to deliver your product or service. HMRC allows you to claim bad debt relief as follows:

1. Work out the VAT on the unpaid Invoice
2. Calculate the VAT that would have been paid if you were paid at your flat rate percentage
3. Subtract step 2 from step 1
4. Include the result of step 3 in your next VAT return

Following on from our example above Jane is an IT Consultant so her VAT flat rate percentage is 14.5%.  Jane raised an invoice to her client for £1,440 (£1,200 plus standard VAT of 20%). After 6 months it transpires that her client is unable to pay the invoice so she wishes to claim for bad debt relief:

• Step 1: The total invoice value is £1,440, which includes VAT of £240 at the standard rate of 20%
• Step 2: Under the rules of Jane’s flat rate scheme, she would need to pay VAT of £174 (£1,200 x 14.5%)
• Step 3: Deducting step 2 from step 1 results in £66 (£240 – £174)
• Step 4: Jane can claim £66 on her next VAT return.

If you use cash accounting you can only claim for bad debt relief if:

• you have not been paid by your customer and it has been 6 months since you made the supplies
• you have not accounted for and paid tax on the supply
• you have written off the debt in your accounts

14. How to Switch from Standard VAT Scheme to Flat Rate VAT Scheme

If you are already VAT registered and using the standard VAT scheme, you can choose to move to the flat rate VAT scheme if you think this will benefit you. You’ll need to complete the VAT600 FRS form mentioned above and you’ll be entitled to claim the 1% discount until the first anniversary of your main VAT registration.