VAT Flat Rate Scheme: explainer and top tips

We all like a bit of simplicity in our lives so it’s a good thing the UK Flat Rate VAT Scheme is designed to simplify the process of calculating and paying Value Added Tax (VAT) for small business -- which contract job-seekers often become by being their own limited company.

Introduced by HM Revenue and Customs (HMRC), the Flat Rate VAT Scheme allows businesses with an annual turnover of £150,000 or less, excluding VAT, to pay a fixed percentage of their total turnover as VAT.

This percentage, writes Richard Grant, a manager at Chart Accountancy, varies depending on the business sector you’re in, so a closer look is invariably required if you’re a limited company and wish to benefit from the simplification which the FRS can offer.

VAT Flat Rate Scheme: Purpose and Benefits

The primary purpose of the Flat Rate VAT Scheme is to reduce the administrative burden on small businesses.

Instead of tracking VAT on every purchase and sale, businesses simply apply a flat rate percentage to their gross turnover. This simplifies record-keeping and the preparation of VAT returns, allowing business owners to focus more on their core activities rather than complex VAT accounting.

One significant benefit of the FRS is the reduction in paperwork. Under the scheme, businesses no longer need to keep detailed records of the VAT they charge and the VAT they reclaim on purchases. This can lead to a significant time-saving and reduce the risk of errors. Additionally, the scheme provides cash flow benefits, as businesses can retain a portion of the VAT they collect.

VAT FRS: Eligibility and Joining

To be eligible for the Flat Rate VAT Scheme, a business (such as your own limited company) must be VAT-registered with HMRC, and have an estimated annual taxable turnover of £150,000 or less, excluding VAT. Once a business joins the scheme, it can remain in it until its total business income exceeds £230,000.

Fortunately, businesses can join the scheme at any time. But a business must apply to HMRC, either online or by post.

Once accepted by HMRC, your business must adhere to the scheme’s rules and use the appropriate flat rate percentage for their own individual sector. Available online, the flat rate percentage rates are determined by HMRC and vary between different industries to reflect the average VAT burden in each sector.

What about Calculation and Reporting on the VAT Flat Rate Scheme?

Under the Flat Rate VAT Scheme, businesses calculate their VAT liability by applying their sector-specific flat rate percentage to their gross turnover, including VAT.

For example, if a business in the retail sector with a flat rate of 7.5% has a gross turnover of £100,000, including VAT, their VAT liability would be £7,500.

Keep in mind, businesses still issue VAT invoices and charge the standard rate of VAT on their sales.

However, if you join the FRS, you’ll not need to reclaim VAT on most purchases, except for certain capital assets over £2,000. The flat rate percentages take into account the input VAT businesses cannot reclaim, hence simplifying the overall process!

Technology Company on the VAT Flat Rate Scheme, an Example...

Let’s consider an IT consulting business operating as a limited company – and for such a technology business, HMRC decrees that the flat rate percentage is 14.5%.

If the IT consultancy’s total gross turnover, including VAT, for a quarter is £20,000, the VAT payable to HMRC would be 14.5% of £20,000, which is £2,900.

This prescribed method significantly simplifies the tech consultancy firm's VAT accounting compared to standard VAT treatment.

VAT FRS: Limitations and Considerations

While the Flat Rate VAT Scheme offers simplicity, it may not always be the most cost-effective option.

Limited companies with high input VAT costs might find that they pay more money under the flat rate than they would under the standard VAT scheme, where they can reclaim VAT on purchases. Therefore, it is crucial for businesses to assess their individual circumstances and tot up whether the scheme is financially beneficial. An accountant can be invaluable here.

Furthermore, the FRS has seen adjustments over time, including the introduction of a higher flat rate for “limited cost” traders in April 2017. This change from HMRC was aimed at businesses with minimal costs to ensure the scheme is used appropriately and to prevent misuse.

TL;DR: Flat Rate Scheme for VAT, worthwhile?

The UK Flat Rate VAT Scheme is a valuable tool for small business including one-person limited company contractors, offering significant simplification in VAT administration.

By reducing paperwork and streamlining the VAT calculation process, the scheme allows business-owners to save time and reduce administrative burdens. However, careful consideration -- ideally with the input of an accountant -- is required to ensure it is the most advantageous option for each business, taking into account their specific cost structures and turnover.