The HMRC VAT Flat Rate Scheme works by simplifying the traditional VAT reporting system to help certain smaller businesses.
This post covers:
- How the VAT Flat Rate Scheme works
- Who is eligible to join the scheme
- The benefits of joining the VAT Flat Rate Scheme
How Does Traditional VAT Work
Normally the VAT, currently at 20%, a business needs to pay or be repaid for is the difference between the VAT charged by a business to its customers and VAT it pays to its suppliers.
So if a business bills £10,000 plus VAT in a quarter and pays suppliers £5,000 plus VAT, it will make a net payment to HMRC of £1,000.
VAT is a charge on consumers not businesses. Business are just responsible for collecting VAT on behalf of HMRC.
What is the VAT Flat Rate Scheme?
For small businesses calculating VAT can be time-consuming and costly in terms of errors or accounting fees.
The VAT flat rate scheme works by allowing businesses:
- to pay a fixed percentage rate of VAT to HMRC based on the VAT inclusive amount billed to customers;
- keep the difference between the VAT charged to customers and paid to suppliers;
- to not reclaim the VAT on any of purchases, except for certain capital assets over £2,000.
An Example of How the VAT Flat Rate Scheme Works
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 industry and it is 14.5%.
Every time Jane raises an invoice to one of her clients she must add 20% VAT onto this invoice.
However, when she submits her VAT return to HMRC, she will apply her fixed percentage of 14.5% to her net sales.
For example, if 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%). She ‘profits’ £260 in this quarter.
This isn’t really profiting as such.
Jane may have paid 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
So the £260 ‘profit’ represents a contribution towards what she has paid out.null
How the VAT Flat Rate Scheme Works
Here’s how the VAT flat rate scheme works, from registering to filling out your first VAT Return:
1. Check You Are Eligible to Join the VAT Flat Rate Scheme
Businesses with a taxable turnover of less than £150,000 are eligible to join the VAT Flat Rate Scheme.
What is Taxable Turnover?
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 or capital goods VAT scheme.
2. Work Out the Flat Rate Percentage applicable to you
HMRC sets out the percentage you should use instead of the standard rate of 20%. These are set according to industries and at a rate that takes account of input VAT that business will generally be paying out.
You can check for the VAT Flat Rate Percentages here but here are some examples:
|Accountancy or book-keeping||14.5%|
|Boarding or care of animals||12%|
|Computer and IT consultancy or data processing||14.5%|
3. Check whether you will be classed as a 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 calledLimited Cost Traders.
A limited cost trader is a business which:
- 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.
Any business that
Find out more about testing whether you are a Limited Cost Trader here.
4. Check your Eligibility for a 1% discount on your Flat Rate Percentage
Some businesses who are in their first year of VAT Flat Rate Scheme registration are eligible to a 1% discount on their flat rate percentage.
5. Check that the VAT Flat Rate Scheme benefits you
The benefits 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;
- Combining the Flat Rate Scheme with Cash Accounting meaning it can really benefit cash flow.
The VAT Flat Rate Scheme may not work for everyone and there is no legal requirement to join the scheme.
Joining the 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 have regular input tax to claim above the ‘profit’ you will make.
6. Register for the VAT Flat Rate Scheme
You can register for the VAT flat rate scheme online or by post. I’ve put together a guide that walks you through the application process and shows you what information you need to provide.
7. Get Your Bookkeeping In Order
Under the rules of the flat rate scheme, you need to keep details of all your invoices and purchases as well as some additional information regarding your flat rate percentage.
Read more about Flat Rate Scheme Bookkeeping and Record Keeping.
8. Start Filling Out Your VAT Returns
You will need to file your VAT returns either quarterly or annually, depending on the scheme you sign up to.
Under the flat rate VAT scheme you still continue to complete the same VAT return as everyone else, but you need to amend your numbers for:
- Your flat rate percentage;
- Purchases depending
Read my step by step guide to Filling Out Your Flat Rate VAT Return, which includes what you need to include in each box.
Updated 26 March 2019
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