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In the ever-changing and complex world of business taxes, the Flat Rate VAT Scheme stands out for its simplicity and efficiency. Designed for small businesses, it streamlines VAT calculations, potentially reducing the administrative burden and freeing up valuable time. This quick guide will explore the ins and outs of the Flat Rate VAT Scheme, ensuring you have all the information needed to decide if it’s the right choice for your business.
How does it work?
The VAT payable to HMRC is determined by the type of trade being carried out by the business. Each trade has a fixed percentage that is determined by HMRC. You can find the latest rates on the HMRC website here.
To calculate VAT, this fixed percentage is applied to the company’s gross turnover and the resulting number is the amount of VAT payable. Compare this to a standard VAT registration, the business would need to add up the VAT charged on sales (output VAT) and the VAT paid on purchases (input VAT). The net of these two numbers is the amount that would need to be paid to HMRC.
You can see that for the most part, the flat rate scheme ignores the calculation of VAT on purchases. The business can keep the difference between what you charge your customers (usually 20%) and the FRS percentage. However, you cannot reclaim VAT on purchases (input VAT) unless the purchase is of a capital asset over £2,000 (including VAT). You may also reclaim VAT on certain purchases of goods and services before registration.
Example Calculation
Dean is a Journalist and has registered for the Flat Rate Scheme. Dean’s gross turnover is £100,000. However, Dean also purchased a new camera during the year for £4,800 (including £800 VAT). HMRC have determined that the VAT flat rate for a photographer is 11%. Therefore:
VAT on Sales (£100,000 x 11%) £11,000
Less: VAT on purchases (£800)
Total VAT payable £10,200
Can I join the Flat Rate Scheme?
You can join the Flat Rate Scheme if you’re registered for VAT and you expect your taxable turnover to be less than £150,000 (excluding VAT) during the year.
You can’t use the scheme if:
- You left the scheme in the last 12 months;
- You committed a VAT offence in the last 12 months;
- You joined (or were eligible to join) a VAT group in the last 24 months;
- You 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; or
- You want to use the cash accounting scheme.
Can I always use the Flat Rate Scheme?
Unfortunately not, you must leave the scheme if:
- You’re no longer eligible to be in it based on the criteria above
- On the anniversary of joining, your turnover in the last 12 months was more than £230,000 (including VAT). Or, you expect it to be in the next 12 months
- You expect your total income in the next 30 days alone to be more than £230,000 (inc. VAT)
Advantages of the Flat Rate VAT scheme
One of the most compelling reasons to consider the Flat Rate VAT Scheme is its potential to reduce the time and effort spent on bookkeeping. By simplifying the VAT process, businesses can allocate more resources to growth activities rather than tax compliance. Additionally, the scheme can sometimes result in a net gain for businesses. This is because the flat rate might be lower than the actual VAT charged to customers.
Beware of the Limited Cost Trader category
What is a Limited Cost Trader and why was it introduced?
The introduction of the Limited Cost Trader category came as a response to prevent potential exploitation of the scheme. Limited Cost Traders must use a higher fixed VAT rate compared to other businesses in the Flat Rate Scheme. The rate for Limited Cost Traders is set at 16.5% of their VAT-inclusive turnover. This rate is notably higher than most other rates within the scheme. However, it reflects the minimal amount of VAT that these businesses would reclaim under the standard VAT system due to their low expenditure on goods and services.
The rule aims to ensure that businesses that spend very little on goods and services, and thus would not reclaim much VAT under the normal VAT system, do not gain a disproportionate advantage from the Flat Rate Scheme.
How do I calculate if I am a Limited Cost Trader?
The definition of a Limited Cost Trader hinges on the amount they spend on goods, services, or both. A business qualifies as a Limited Cost Trader specifically if, during a prescribed accounting period, its VAT-inclusive expenditure on goods and services is either:
- Less than 2% of their VAT-inclusive turnover, or
- More than 2% of their VAT-inclusive turnover but less than £1,000 per year (if the prescribed accounting period is one year; if it’s less, this threshold is proportionally reduced).
It’s important to note that the definition of goods for this purpose does not include capital goods (like new equipment for business use), food and drink (consumed by the business or its employees), or vehicles and vehicle parts (unless the business is one that hires out vehicles or sells them).
Reduction of 1% in your first year of VAT registration
In the first year of VAT registration, there is a 1% discount applied to your turnover. This reduction applies for 12 months from the date of registration.
When should you avoid using the Flat Rate VAT scheme?
It may not be a wise decision to join the flat rate taxable sales scheme if you make a lot of VAT-exempt sales as the scheme includes such sales. This might result in you paying more VAT. Similarly, if you have a lot of zero-rated sales or if you purchase many standard-rated goods and services, joining the scheme could increase your VAT costs. If you’re not part of the Flat Rate Scheme, you would typically receive a quarterly refund from HMRC which you’d lose if you joined the scheme.
How can I join the FRS?
You can apply online when you register for VAT. Alternatively, you can complete form VAT600FRS and send it to HMRC.
Conclusion: Is the Flat Rate VAT Scheme Right for You?
The Flat Rate VAT Scheme represents an attractive option for small businesses seeking to simplify their VAT obligations. By understanding the nuances of the scheme and carefully considering its impact on your business, you can make an informed decision about whether it’s the right choice for your business. With the potential for reduced administrative burdens and improved financial efficiency, the Flat Rate VAT Scheme is a valuable tool in the arsenal of any small business navigating the complexities of VAT.