HMRC has launched many different VAT schemes and, although it can make things confusing when it comes to choosing the best one for you, they are designed to help with cash flow and reducing administration.
Still confused about the basics of VAT? Read this overview of the UK VAT system
What VAT Schemes are there?
Over the years HMRC have introduced several different schemes, designed with small businesses in mind.
Here’s an overview of the main schemes HMRC have put together:
Standard VAT Scheme
This is the one most commonly used in the UK. Under the rules of the standard scheme business charge their customers VAT and claim back VAT they have paid, based on invoice date.
You can claim back VAT on the things you buy when you are invoiced for them rather than when you have paid for them (which is relevant if you take credit from your suppliers)
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.
With this 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.
You’ll pay VAT on invoices that your customers have paid. It can be combined with other schemes such as the standard scheme or flat rate scheme, making managing VAT even easier.
You can only claim back VAT on the purchases you have paid for, regardless of the invoice date.
Read more about Cash Accounting
The Annual Accounting Scheme lets small businesses submit, 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 return is submitted.
It reduces administration and the monthly payments are predictable, which is great for cashflow.
The annual accounting scheme doesn’t really suit businesses who expect to receive VAT repayments. And with only an annual requirement, businesses can put off staying on top of their VAT record keeping and administration.
Read more about Annual Accounting
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:
- Pay a fixed percentage rate of VAT on its sales to HMRC based on the VAT inclusive amount billed to their customers;
- Keep the difference between the VAT charged to customers and actually paid to HMRC;
- Not reclaim the VAT on any of purchases, except for certain capital assets over £2,000.
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 rate of VAT than the standard rate (although HMRC has clamped down on this by introducing the limited cost trader guidelines).
If your business is expecting to receive VAT repayments, for example because you are new in business and are buying costs to get set up, then the flat rate scheme may not be beneficial.
Read more about the Flat Rate Scheme
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 the number of items sold in a quarter and the amount spent on new purchases.
Business 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
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.
Read more about the Global Accounting Scheme
VAT MOSS is less of a choice, with businesses who 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 business of all sizes in the EU.
Read more about VAT MOSS
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.
Business 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.
Accounting for VAT and record keeping can be slightly more complicated to handle, with many softwares unable to cope with calculating the 1/6th difference.
Read more about the Second-Hand Margin Scheme
VAT Reverse Charge
The VAT Reverse Charge simplifies the VAT process where services are supplied between the UK and other EU countries. The reverse charge rules generally cover B2B transactions across EU member states.
Customers avoid paying VAT and the time it takes to claim back what they have paid on their next VAT return.
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.
Read more about the VAT Reverse Charge
Choosing the Best VAT Scheme for Your Business
Which VAT scheme is right for you depends on many factors including:
- the type of business you have;
- what stage your business is at;
- the level of expenses you pay for;
- how you get paid by your customers and when;
- whether you take credit from your suppliers.
Each scheme has different rules which will also determine whether you are eligible to join them. So research each scheme to decide which one will work best for you 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 your business on an ongoing basis, because in some cases you can change VAT schemes so you can move to something more beneficial.
How to Change VAT Schemes
Changing VAT schemes will usually need the approval of HMRC because the way you account for VAT will changing 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. But remember you can’t swap and change quarter by quarter to choose the one that suits you – you need to stick with it.
New Here? Learn how to set up the financial side of your business with these easy to understand guides and resources:
- Sole Trader or Limited Company? – Download my free calculator to check which business structure would help you to pay less tax;
- Tax Records and Bookkeeping – Understand what tax records you’ll need to keep and how to set up your own bookkeeping system;
- Self Employment Taxes Explained – Learn what taxes you’ll pay, how much and when;
- VAT Guides – From registration to de-registration, VAT schemes and thresholds, these guides will take you through the basics every UK small business owner needs to know;
- Invoice Template – Free template and step-by-step guide so you can get paid by your clients.