VAT Schemes Explained

HMRC have launched various different VAT schemes, which businesses can opt into if they feel it will bring benefit in the form of cash flow, reduced VAT bills and administration. In this guide, you’ll find different UK VAT schemes, along with the pros and cons of each.

Updated 29 June 2021

1. VAT Accounting Schemes

Normally when a business registers for VAT, they are by default expected to account for VAT on invoices according to when they are dated and reported to HMRC on quarterly VAT returns – this is known as the standard VAT scheme.

VAT accounting schemes allow certain changes to the standard scheme rules which aids cashflow and simplifies reporting, amongst other things. Here are the main UK VAT schemes that businesses can apply to join:

1.1 Standard VAT Scheme

The standard VAT scheme is the default scheme businesses must use once they register for VAT. Under the rules of the standard scheme, businesses are expected to account for VAT on invoices according to when the invoice date and report to HMRC on quarterly VAT returns.

Pros

The main pro of the standard scheme is that you can claim back VAT on expenses when you are invoiced for them rather than when you have paid for them (which is useful if you take credit from your suppliers).

Cons

The drawback of the standard VAT scheme is that you have to pay VAT over on all your sales invoices regardless of whether your customers have paid you, which if you have slow payers, can cause you a cash flow problem.

1.2 Cash Accounting

With the VAT cash accounting scheme you only pay VAT to HMRC once your customers have paid you, but you can only claim back VAT on purchases when you have paid for them.

Pros

You’ll pay VAT on invoices that your customers have paid. The cash accounting scheme can be combined with some other VAT schemes making the impact on the business even more beneficial.

Cons

You can only claim back VAT on the purchases you have paid for, regardless of the invoice date. So if a business had made credit purchases, they won’t get the benefit of claiming back VAT on expenses until those invoices are paid.

1.3 Annual Accounting

The annual accounting VAT scheme lets small businesses, with a taxable turnover is £1.35m or less over the next 12 months, submit one VAT return per year. Businesses are required to make monthly advance payments towards this annual VAT return, along with a balancing payment, if required, when the annual VAT return is submitted.

Pros

This VAT scheme really reduces administration and the monthly payments are predictable, which is great for cashflow.

Cons

The annual accounting scheme doesn’t really suit businesses that expect to receive VAT repayments. And with only an annual reporting requirement, businesses can put off staying on top of their VAT record keeping and receipts without the quarterly requirement to keep them on track.

1.4 Flat Rate Scheme

The flat rate VAT scheme aims to simplify VAT for small businesses helping to avoid the costs of accounting fees, errors and save business administration time. Under the rules of the VAT flat rate scheme businesses must:

  1. Pay a fixed percentage rate of VAT on its sales to HMRC 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. Not reclaim the VAT on any of purchases, except for certain capital assets over £2,000.

Pros

This scheme definitely simplifies VAT reporting and record-keeping and businesses registering for the first time may be eligible for an additional 1% reduction of their flat-rate percentage for one year.

Some businesses can even potentially make money from this scheme because they benefit from using a lower VAT rate than the standard rate (although HMRC has clamped down on this by introducing the limited cost trader guidelines).

Cons

If a business is expecting to receive VAT repayments, for example, because it is a new business setup, then the flat rate scheme may not be beneficial.

1.5 Global Accounting

The Global Accounting scheme is only available to certain types of businesses such as second-hand goods or antique dealers. Eligible businesses pay 1/6th of the difference between items sold in a vat period and the amount spent on new purchases.

Pros

Businesses eligible to join this VAT scheme generally sell to the public. So if they reach the VAT registration threshold adding VAT to their sales prices can make them uncompetitive in the marketplace. And taking out VAT from the current sales price will erode margins. Paying 1/6th of the difference between the sales price and purchase price can help mitigate the impact of a VAT registration.

Cons

Accounting for VAT and record-keeping can be slightly more complicated to handle, with many software unable to cope with calculating the 1/6th difference. That makes administration for the global accounting scheme more time consuming and, in some cases, more expensive.

1.6 VAT MOSS

VAT MOSS is less of a choice, with businesses that supply certain electronic products being forced to join this scheme. It is a VAT Scheme designed by HMRC to try to create a level playing field between digital services businesses of all sizes in the EU.

1.7 Second-Hand Margin Scheme

The VAT margin scheme saves money for businesses whose turnover has reached the VAT registration threshold, but buy and sell second-hand or reconditioned goods to the general public or non-VAT registered businesses.

Similar to the global accounting scheme, this VAT scheme lets businesses pay VAT at 16.67% (one-sixth) of the difference between the price you pay for an item and what you sell it on for.

Pros

Businesses eligible to join this VAT scheme generally sell to the public, so if they reach the VAT registration threshold (currently based on a turnover of £85,000), adding VAT to their sales prices can make them uncompetitive in the marketplace. And taking out VAT from the current sales price will erode margins. Paying 1/6th of the difference between the sales price and purchase price can help mitigate the impact of a VAT registration.

Cons

Accounting for VAT and record-keeping can be slightly more complicated to handle, with many software unable to cope with calculating the 1/6th difference. That makes administration for the global accounting scheme more time consuming and, in some cases, more expensive.

1.8 VAT Reverse Charge

The VAT Reverse Charge simplifies the VAT process where services (not products) are supplied between the UK and other EU countries.  The reverse charge rules generally cover B2B transactions across EU member states.

Pros

Customers avoid paying VAT and the time it takes to claim back what they have paid on their next VAT return.

Cons

Accounting for the VAT reverse charge can be the source of some confusion and guidelines on handling reverse charge VAT once Brexit takes place are still sketchy.

2. How to Choose the Right VAT Accounting Scheme

Which VAT scheme is right for a business depends on many factors including:

  • the type of business;
  • what stage the business is at;
  • the level of expenses incurred;
  • how customers pay and when;
  • whether the business takes credit from suppliers.

Each VAT scheme has different rules which will also determine whether a business is eligible to join them. So research each scheme to decide which one will work best and if in doubt always seek the help of a professional. It also makes sense to learn which VAT schemes there are available and review the business on an ongoing basis, because in some cases a change in VAT schemes can become beneficial as a business grows and evolves.

3. How to Change VAT Schemes

Changing VAT schemes will usually need the approval of HMRC because the way you account for VAT will change, meaning you’ll need to complete a final VAT return for your old scheme, and then start a new VAT quarter using your new scheme.

For example, if you wanted to swap from the standard VAT scheme to the Flat Rate you’d need to go online and request the change in your VAT account.

But when it comes to the cash accounting scheme, you don’t need to actually notify HMRC just adopt it. Remember you can’t swap and change quarter by quarter to choose the one that suits you – you need to stick with it.

About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek, money nerd and creator of www.goselfemployed.co - the UK small business finance blog for the self-employed community. Here she shares simple, straight-forward guides to make self-employment topics like taxes, bookkeeping and banking easy to understand.