VAT Flat Rate Scheme: How It Works and Who It Suits

The VAT flat rate scheme lets an eligible business pay HMRC a fixed percentage of its VAT-inclusive turnover instead of netting off VAT on sales and purchases. Customers are still charged VAT at the normal rate. The percentage depends on the trade sector, and businesses spending very little on goods pay 16.5%.

At 16.5%, a £1,000 job billed at £1,200 including VAT leaves you just £2 of the £200 VAT you collected. The same invoice at the 13% hairdressing rate leaves £44. That margin is all there is to cover the VAT on your own costs, which day-to-day spending can’t claim back.

This guide is for businesses weighing up the VAT flat rate scheme with taxable turnover of £150,000 or less, excluding VAT, expected over the next 12 months. Your sector and whether you’re a limited cost trader decide which rate applies, with 1% off in your first year of VAT registration.

Whether it’s worth it depends on how much income is zero-rated or exempt, and on any big equipment you’re planning to buy.

How the VAT flat rate scheme works

Nothing changes on your invoices. You still charge VAT at the normal rate for each sale, and you still issue VAT invoices to customers who are VAT registered themselves.

The change comes at the end of each VAT period. Rather than subtracting the VAT on your purchases from the VAT on your sales (the usual split between input VAT and output VAT), you multiply your VAT-inclusive takings by your flat rate and pay HMRC the result.

Day-to-day purchases don’t get a VAT reclaim, apart from the capital goods exception covered below.

That VAT-inclusive total is your flat rate turnover. It covers standard-rated, reduced-rate and zero-rated sales, plus VAT-exempt income like rent. Because zero-rated and exempt income gets the percentage too, a business with more of it than the average for its sector may pay more than under normal accounting.

Bank interest and private income stay out, as do sales of capital goods you reclaimed VAT on.

You measure flat rate turnover in one of three ways, and once you’ve picked one you stick with it for at least 12 months:

• Basic turnover counts sales by their tax point, which is often the date you issue the invoice.
• Cash-based turnover counts the money you’ve actually been paid during the period.
• Retailer’s turnover starts from your daily takings and adds any other business income.

Your percentage comes from the trade sector that best describes your main activity, judged by turnover, and one rate covers everything the business sells. HMRC publishes the full list of flat rates by business type and won’t change your choice later if it was reasonable, so note down why you picked it.

The flat rate scheme first year discount knocks 1% off your percentage until the day before the first anniversary of your VAT registration. It runs from registration, not from joining, so joining eight months after registering leaves four months of discount. You lose it entirely if your VAT registration came 12 months after it should have.

If the nature of the business changes, the new sector rate applies from the date of the change, and you must write to HMRC within 30 days. A shift in the mix between activities you already do waits for the anniversary of joining, with any new rate applying from the start of the VAT period that anniversary falls in.

Flat rate scheme eligibility turns on one forecast

You can apply to join the VAT flat rate scheme if your taxable turnover for the next 12 months, excluding VAT, will be £150,000 or less. That’s the flat rate scheme turnover limit, and it’s a test of the year ahead. Taxable turnover here includes your standard-rated, reduced-rate and zero-rated sales but leaves out any sales of capital assets.

HMRC accepts any reasonable forecast. After a year of VAT registration, your past returns can guide it, allowing for changes you expect. If you’re not yet registered, trading so far, a previous owner’s figures, or business plans and loan applications can all feed in.

Keep the workings. Beating a forecast that had reasonable grounds brings no penalty, but without a reasonable basis HMRC may remove you from the scheme straight away or backdate the removal.

Any one of these rules you out:

• You aren’t VAT registered, although you can register and join at the same time.
• You left the flat rate scheme within the last 12 months.
• Within the last 12 months, you’ve been convicted of a VAT offence, accepted a compound penalty or been penalised for dishonest conduct.
• Your business is registered as a VAT group or division, or is eligible to join an existing VAT group, or has been either at any point in the last 24 months.
• You account for VAT through the second-hand goods margin scheme or the auctioneers’ scheme, or you’re required to use the Tour Operators’ Margin Scheme or the Capital Goods Scheme.
• Your business counts as associated with another if one is under the other’s main influence, the two are tied together by close financial, economic and organisational links, another company has the right to direct yours, or yours in practice keeps following another’s directions.

HMRC can still agree in writing to let a business in where its past group eligibility or association poses no risk to the revenue.

Some supplies sit outside the scheme even once you’re in. Anything under a VAT domestic reverse charge can’t go through it, including the one for building and construction services. It can’t run alongside the cash accounting scheme or a retail scheme either, since it has cash-based and retail methods of its own.

Limited cost trader status means a 16.5% rate

Since 1 April 2017, a business that spends very little on goods has used a flat rate of 16.5%, whichever sector it’s in. HMRC’s guidance calls it a limited cost business, and the legislation a limited-cost trader. The first-year 1% comes off this rate too, making it 15.5%.

The test runs for every VAT return. Add up what you spent on relevant goods in the period, including VAT, and compare it with the higher of two figures: 2% of your flat rate turnover, or £1,000 a year (£250 for a quarterly return). Spend less than that and you’re a limited cost trader for the period. Spend exactly that amount or more and your sector rate applies.

On £14,400 of quarterly turnover, 2% is £288, which beats £250. Goods spend of £287 puts you on 16.5%, while £288 keeps your sector rate.

The test counts goods used solely in the business, with these left out:

• Services don’t count, so accountancy fees, advertising, rent and downloaded software are all out.
• Capital goods don’t count at any price, which rules out a laptop or phone for the business.
• Food and drink for yourself or your employees don’t count.
• Vehicles, vehicle parts and fuel are left out unless the business sits in the transport sector (couriers, freight, removals or taxis) and owns or leases the vehicle.
• Goods you buy to resell or hire out don’t count unless that’s your main business, and neither do gifts, promotional items or donations.

Stationery, stock for a shop and hair products used on clients all count. More examples sit in HMRC’s VAT Notice 733.

You can be on 16.5% one quarter and your sector rate the next without writing to HMRC. Keep the goods figure with your flat rate calculation, as HMRC requires it in the record kept with your VAT account.

Run both sums before you decide

Is the flat rate scheme worth it? It comes down to one comparison: the VAT you’d hand over at your flat rate against what you’d pay under normal accounting after reclaiming VAT on your costs. Flat rates are averages, so HMRC’s own guidance warns you may pay more, and the scheme doesn’t suit a business that regularly gets VAT repayments.

Here are two businesses over one quarter, with all their sales standard-rated and figures chosen for illustration:

The consultant’s £120 of stationery sits below £288 (2% of £14,400), so 16.5% applies and the scheme costs £66 a quarter more than normal accounting. In the first year of VAT registration, the 15.5% rate turns that into a £78 saving.

The hairdresser’s product spend clears the test easily, and the 13% rate leaves £370 a quarter in the business, or £580 in year one at 12%.

To test your own figures, take the VAT you charge in a quarter and subtract your flat rate payment. That’s your break-even point: if you’d reclaim more input VAT than that under normal accounting, the scheme costs you money. For the consultant it’s £24 a quarter, and for the hairdresser it’s £770.

Big capital purchases still get their VAT back

The flat rate scheme capital goods exception lets you reclaim VAT on big equipment even inside the VAT flat rate scheme. If a single purchase of capital goods costs £2,000 or more including VAT, you claim the VAT on it outside the flat rate calculation, in box 4 of your return.

Capital goods are things the business keeps and uses for years, like a van, a computer or a machine, wearing out only through use. Goods don’t qualify as capital goods under the scheme in these cases:

• You bought them to resell, or to build into goods you sell.
• You’ll use them up within a year.
• You bought them to earn income by hiring, leasing or letting them out, even indirectly, so a van used for deliveries in the week and hired out at weekends is excluded whatever it cost.
• They fall under the Capital Goods Scheme, which means leaving the flat rate scheme altogether.

Services don’t qualify either. A van you lease or hire is a service, while one bought on hire purchase counts as goods. Nothing under £2,000 qualifies.

Whether something is one purchase or several follows the normal VAT rules. A café buying a coffee machine, a fridge and a glasswasher together from one supplier at one time makes a single purchase, so the combined bill counts towards £2,000. Buy them from three suppliers, or on three separate occasions, and each one has to reach £2,000 on its own.

There’s no apportioning for planned personal use, so the claim isn’t cut because the equipment will sometimes be used privately. When you sell the item later, the sale carries VAT at the normal rate, accounted for outside the flat rate calculation.

Joining and leaving the flat rate scheme

You can join during VAT registration or once you’re already registered, and several of the rules that bar you from joining will also force you out if they start to apply after you’re in.

How to join the flat rate scheme

Not VAT registered yet? You can join the flat rate scheme as part of your VAT registration, and the sole trader VAT registration guide walks through that side. Already registered?

Apply to join online with your Government Gateway login. If you can’t use the online service, fill in form VAT600FRS and post or email it to HMRC.

The application asks for your business name, address and phone number, your VAT number (or registration reference if it hasn’t arrived), your main business activity and a start date. Give the full flat rate for your sector, even if the first-year 1% applies. HMRC confirms in writing, and your start date will normally be the beginning of the VAT period after it gets your application.

The scheme works alongside annual accounting, so you can do the flat rate calculation once a year rather than every quarter. Using both means paying HMRC electronically, and if you’re already registered, annual accounting needs its own application on form VAT600AA.

When you have to leave the flat rate scheme

Check your turnover at every anniversary of joining, and at least monthly if the business is growing fast. You have to leave the flat rate scheme in these situations:

• At an anniversary, your VAT-inclusive income for the year just ended is more than £230,000, not counting sales of capital assets.
• You have reasonable grounds to expect more than £230,000 of income in the next 30 days alone, again not counting sales of capital assets.
• You become eligible to join a VAT group, become associated with another business, or register in divisions.
• You need the Tour Operators’ Margin Scheme, expect to buy a Capital Goods Scheme asset, or switch to a margin scheme for second-hand goods or the auctioneers’ scheme.

A one-off spike at the anniversary check doesn’t have to end it. If you expect VAT-inclusive turnover over the next 12 months not to exceed £191,500, HMRC may let you stay on written application, provided the jump was unexpected, won’t recur and came from genuine commercial activity. That route isn’t open if it’s the 30-day test you’ve failed.

To leave by choice, contact HMRC at any time and it’ll confirm your leaving date. You can’t rejoin for 12 months afterwards. If your stock of standard-rated goods has grown while you were in the scheme, you may be able to claim back some VAT on it in your first return afterwards.

Before you join the VAT flat rate scheme

The VAT flat rate scheme swaps the usual VAT sum for a single percentage of your VAT-inclusive turnover, and whether that saves money depends on your own numbers.

Work out whether you’d be a limited cost trader first, because 16.5% leaves almost nothing of the VAT you charge. After that, run one quarter both ways and compare the result with your break-even point.

If you’re planning a big equipment purchase, check it’ll count as a single capital goods purchase of £2,000 or more. Keep your turnover forecast and your goods figure on file, and put each anniversary of joining in the diary for the £230,000 check.

For how the flat rate scheme sits alongside the other VAT schemes, the VAT guide covers the wider picture.

Key Takeaways

• You still charge VAT at the normal rate, and the flat rate only changes what you pay HMRC, worked out on VAT-inclusive turnover.
• You can join if taxable turnover for the next 12 months, excluding VAT, will be £150,000 or less, and income growing past £230,000 is one of the triggers for having to leave.
• A limited cost trader pays 16.5%, which applies when spend on relevant goods in a return period is below the higher of 2% of flat rate turnover and £1,000 a year pro rata.
• The flat rate scheme first year discount takes 1% off until the day before the first anniversary of VAT registration, including off the 16.5% rate.
• VAT on a single capital goods purchase of £2,000 or more, including VAT, can still be reclaimed, while services and smaller purchases stay inside the flat rate.