When it comes to VAT registration, small businesses and self-employed individuals often grapple with the complexity of VAT returns.
Read more on VAT here!
The Flat Rate VAT Scheme (FRS) offers a simpler alternative for small businesses, designed to reduce the administrative burden while keeping your tax obligations in check.
Let’s make it as easy as 1, 2, 3… 4, 5, 6, 7, 8 and learn about the details of the Flat Rate VAT Scheme, its eligibility, how it works, and whether it’s the right option for your business.
Don’t have time? Here’s the wrap-up of this article in less time it takes to eat a taco 🌮
▪ The Flat Rate VAT Scheme simplifies VAT for small businesses by applying a flat percentage to your gross turnover.
▪ Eligible businesses must have an expected taxable turnover of less than £150,000 in the next 12 months.
▪ The scheme is optional and simplifies VAT calculations, but doesn’t allow VAT reclaims except for certain capital assets.
▪ Limited Cost Traders pay a higher rate of 16.5% due to lower spend on goods.
▪ You’ll need to leave the scheme if your turnover exceeds £230,000.
▪ For How to Operate the Flat Rate VAT Scheme (FRS) check out this detailed guide.
▪ n.b. Stay Sharp, Stay Savvy and Keep Winning.
Skip right to…
- What is the Flat Rate VAT Scheme?
- 1- So What Are We Talking About Exactly?
- 2- How Does the Flat Rate VAT Scheme Work?
- 3- Eligibility Criteria for the Flat Rate VAT Scheme
- 4- Flat Rate VAT Scheme for Limited Cost Traders
- 5- Flat Rate VAT Scheme vs. Standard Rate VAT Scheme
- 6- What Are the Benefits of the Flat Rate VAT Scheme?
- 7- What Are the Disadvantages of the Flat Rate VAT Scheme?
- 8- Deciding Which VAT Scheme is Right for You
- Conclusion: Final Thoughts
What is the Flat Rate VAT Scheme?
1- So What Are We Talking About Exactly?
The Flat Rate VAT Scheme (FRS) was introduced to help small businesses simplify their VAT processes. Instead of tracking input and output VAT like in the Standard VAT scheme, businesses using the FRS simply apply a flat-rate percentage to their gross turnover, which includes the VAT paid by customers. This flat rate depends on the nature of the business, making VAT easier to manage and calculate.
For example, an accountant using the scheme with a gross VAT-inclusive turnover of £120,000 will apply a flat rate of 14.5% to determine their VAT payable to HMRC. In this case, the VAT liability would be £17,400 (£120,000 x 14.5%).
2- How Does the Flat Rate VAT Scheme Work?
The beauty of the FRS lies in its simplicity:
▪ Flat-Rate Percentage: You apply a fixed percentage to your gross turnover. This rate is predetermined based on your industry.
▪ No VAT Reclaims: Unlike the Standard Rate VAT scheme, you cannot reclaim VAT on goods and services you purchase, except for capital assets that cost £2,000 or more.
▪ Simplified Administration: Instead of tracking every bit of input and output VAT, you just calculate VAT on your total sales.
▪ First-Year Discount: New businesses get a 1% discount for the first 12 months of being VAT-registered, making it even more attractive during the early stages.
For example, let’s say your business has a gross turnover of £100,000, and you operate in a sector with a 12% flat rate. Your VAT liability will be £12,000 for that period, even if your actual VAT expenses vary.
3- Eligibility Criteria for the Flat Rate VAT Scheme
To join the Flat Rate VAT Scheme, you must:
1- Be VAT-Registered: Your business must be VAT-registered to apply.
2- Turnover Threshold: Your VAT-taxable turnover must be less than £150,000 in the next 12 months.
3- Exit Threshold: You must leave the scheme if your VAT-inclusive turnover exceeds £230,000 over the previous 12 months or if you expect it to exceed this in the next 12 months.
4- Flat Rate VAT Scheme for Limited Cost Traders
In 2017, the Government introduced changes that impact companies known as Limited Cost Traders.
These are businesses that spend very little on goods:
▪ Limited Cost Trader Conditions: You’re a limited cost trader if you spend less than 2% of your VAT-inclusive turnover or less than £1,000 annually on goods (whichever is higher).
▪ Higher VAT Rate: Limited cost traders are required to pay VAT at a flat rate of 16.5%, which is higher than standard rates for most industries. This mostly applies to businesses that primarily offer services with minimal material expenses, such as consultants or service providers.
5- Flat Rate VAT Scheme vs. Standard Rate VAT Scheme
The key difference between the Flat Rate Scheme and the Standard Rate VAT Scheme is how VAT is calculated:
▪ Standard Rate VAT: Businesses charge VAT on their sales (output VAT) and reclaim VAT on their purchases (input VAT). The difference is either paid to HMRC or refunded.
▪ Flat Rate VAT: VAT is calculated as a percentage of gross turnover, depending on the business type. You don’t reclaim VAT on most purchases but are relieved of the complexity of detailed VAT records.
The Standard Rate Scheme can be advantageous if you have significant VAT-reclaimable expenses. However, for businesses with fewer reclaimable costs, the Flat Rate Scheme simplifies the process and saves time.
6- What Are the Benefits of the Flat Rate VAT Scheme?
1- Simplified Administration: No need for meticulous tracking of VAT on every transaction. You only need to apply a flat percentage to your gross turnover.
2- Potential to Increase Cash Flow: The difference between the VAT you charge and what you pay to HMRC can result in extra turnover for your business, especially if your operating costs are low.
3- Reduced Risk of Errors: By avoiding complex input VAT reclaims, you reduce the risk of making errors in your VAT returns, leading to potential penalties.
7- What Are the Disadvantages of the Flat Rate VAT Scheme?
1- No VAT Reclaims on Purchases: Apart from some capital goods over £2,000, you cannot reclaim VAT on purchases.
2- Limited Cost Trader Rules: If you fall under the Limited Cost Trader category, the 16.5% VAT rate may result in higher VAT liabilities compared to other businesses.
3- Eligibility Restrictions: The scheme is only suitable for businesses with lower annual turnovers and may not be suitable as your business grows.
8- Deciding Which VAT Scheme is Right for You
Choosing between the Flat Rate VAT Scheme and the Standard Rate VAT Scheme depends on various factors, including:
▪ The sector you operate in.
▪ The level of company turnover.
▪ Your business’s spending on goods.
▪ The amount of VAT you could reclaim using the Standard Rate.
Businesses with minimal input VAT to reclaim and lower spending on goods often benefit from the simplicity of the Flat Rate Scheme, while those with higher costs may save more under the Standard Scheme.
Conclusion: Final Thoughts
The Flat Rate VAT Scheme provides a simplified and more predictable way of calculating VAT liabilities for smaller businesses. It reduces the administrative burden and makes VAT easier to manage, especially for service-based companies or businesses with minimal expenses. However, like all tax schemes, the Flat Rate Scheme has its pros and cons.
Careful consideration of your industry, spending patterns, and VAT reclaim potential will help determine which VAT scheme is the best fit for your business.
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Our mission is to bring business and personal finance to life and empower you, yes you: the side hustler, the entrepreneurs, parent, start-up, student). We plan to grow this blog and give away everything you could possibly need to know.
Through OMB Connect’s dedicated courses, we walk you through real life examples of registering, setting up, and managing VAT. From connecting MTD with your accountancy software to bookkeeping and filing you own VAT returns.
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