Understanding the VAT Flat Rate Scheme

The Value Added Tax (VAT) flat rate scheme was introduced to simplify the VAT accounting process for small businesses so they can focus more of their time on running their small business, and less on the books.

Under the scheme, although you can’t reclaim VAT on purchases, like under normal VAT rules, this point is accounted for when calculating a flat rate percentage for your business sector, with businesses under the flat rate scheme paying anything between 4-14.5% VAT.

Who Can (and Cannot) Join the Flat Rate Scheme

Though the scheme is optional, there are strict rules surrounding who can and cannot join the flat rate scheme, with the number on criteria for joining being that your estimated taxable turnover in the next year will be £150,000 or under, excluding VAT.

Once you’re a part of the flat rate scheme you may stay in it until your total business income is over £230,000, at which point you must contact HMRC.

With that said, you cannot join the scheme if:

  • You’ve been convicted of a VAT offence in the last twelve months,
  • You’ve previously left the scheme in the last twelve months,
  • Your business is closely associated with another business,
  • You are (or have been within the previous two years) eligible to join an existing VAT group,
  • You use a margin scheme for second-hand items, art, antiques and collectibles, the Tour Operators’ Margin Scheme, or the Capital Goods Scheme.

Flat Rate Advantages and Disadvantages

For the majority of small businesses the advantages of joining the flat rate scheme outweigh the disadvantages, though this isn’t always the case.

The main advantages of joining the scheme are:

  • You don’t need to note down the VAT charged on every sale and purchase, meaning you can focus more of your energy on your business, and less on the books. You will, however, need to show VAT separately on your invoices (see the section on invoicing and record keeping below).
  • A 1% reduction from your flat rate percentage if you are in your first year of VAT registration, eligible up to the day before the first anniversary of you becoming registered.
  • Improved peace of mind. Fewer and less complicated rules helps to simply your VAT process, dramatically reducing the chance of mistakes being made.
  • Much improved tax-planning. When you know what percentage of your income you’ll have to hand over to HMRC each year tax planning becomes significantly easier.

Potential disadvantages of joining the scheme are:

  • You can’t reclaim any VAT back on standard-rated purchases (see the section on handling capital assets below).
  • You won’t be able to receive VAT repayment, as occurs under standard VAT accounting rules.
  • Even if you make a large number of zero-rated or exempt sales, you’ll pay the exact same flat tax rate as if you were making standard-rated sales.

Know Your Percentage

Once in the scheme you will have to calculate your total tax due by applying a specific flat rate percentage to your turnover over the period in question. This percentage varies by sector, with a full, current list available directly from HMRC.

If you believe your business activity over the coming year will cross sectors, you must choose the sector which best describes your main business activity, and apply that percentage across your total business turnover. This rule works in your favour if your secondary business sector is on the higher end of the percentage scale, taking up a fair portion of your business activities, and your main business activity falls under a much lower taxable percentage.

Don’t forget that you’ll receive a one percent reduction from your flat rate percentage if you are in your first year of VAT registration.

Invoicing and Record Keeping

Under the VAT flat rate scheme you must continue to keep accurate records of your business turnover, the particular flat rate percentage you have used, and the tax you have determined to be due.

Despite only having to pay HMRC a flat percentage of your turnover, you’re still required to show VAT at the appropriate normal rate (standard, reduced or zero) on your invoices. Once it comes time to complete your VAT return under the flat rate scheme you’ll need to complete a standard return in a slightly different manner, with HMRC providing ample support in this area.

Handling Capital Assets

In general, under the scheme you can’t claim back the VAT you spend on capital assets purchased for your business, as this is already taken into account in the lower percentage you pay as a flat rate. That said, in certain circumstances you may deal with capital assets totalling over £2,000 (including VAT) outside of the scheme.

There are numerous rules surrounding what these capital assets can be, with a full list of requirements available from HMRC. In situations where you are able to reclaim input VAT in a normal manner you are also required to account for VAT at the normal rate when you eventually sell on the asset in question.

Leaving the Flat Rate Scheme

Though you may only enter the flat rate scheme if your annual taxable turnover is £150,000 or under, you may remain in the scheme until your total business income is over £230,000, at which point you must contact HMRC.

You may also leave the scheme voluntarily at any time.

Would You Benefit from the VAT Flat Rate Scheme?

To speak with a professional to discuss whether the VAT flat rate scheme is right for you, or for any other reason, contact us today on 020 8108 0090 or get in touch with us via our contact page to arrange a complimentary, no-obligation meeting.