Sarah Bradford looks at the pros and cons of the VAT flat rate scheme.
The VAT flat rate scheme is a simplified VAT scheme. It can potentially save a lot of work and may also save tax. However, it is not for everyone and, depending on the nature of the owner’s business, they might find themselves worse off.
Nature of the scheme
The details of the scheme are set out in VAT Notice 733: Flat Rate Scheme for small businesses. The Notice can be found on the Gov.uk website (https://tinyurl.com/yckpy35s).
The scheme is designed to simplify the process of accounting for VAT and working out the VAT that traders need to pay over to HMRC at the end of each quarter. Instead of keeping detailed records of the VAT on all sales and purchases and working out the difference between VAT charged and VAT suffered at the end of the quarter, traders simply apply a fixed percentage to their gross turnover to arrive at the amount they need to pay over to HMRC.
The percentages vary depending on the business sector. These are available on the Gov.uk website.
Eligibility
The scheme is open to businesses registered or eligible to be registered for VAT whose taxable turnover excluding VAT is expected to be £150,000 or less in the next 12 months.
When working out whether you are eligible to join the scheme, taxable turnover excludes any anticipated sales of capital assets but includes:
- the value of standard rate, zero rate and reduced rate supplies;
- turnover from the sale of second hand goods sold outside the VAT margin scheme; and
- any sales of investment gold (within VATA 1994, s 55).
If, after joining the scheme, your turnover increases above £150,000, you will not necessarily need to leave the scheme. However, you will no longer be eligible to use it if your turnover for a year that is ending exceeds £230,000 including taxable and exempt supplies (although HMRC may allow you to remain in the scheme if your forecast turnover for the following year will not exceed £191,500).
You cannot use the scheme if:
- you are not registered for VAT;
- you use the second hand margin scheme or the auctioneers’ VAT margin scheme;
- you are required to operate the capital goods scheme for certain capital items;
- you were assessed with a penalty involving dishonesty, accepted a compound penalty or were convicted of a VAT offence in the 12 months prior to applying to join the scheme; or
- you are part of a VAT group, or your business is associated with another business in a way that means you are not eligible to join the scheme.
If you have used the VAT flat rate scheme previously, once you have left, you cannot rejoin for another 12 months.
Calculating VAT under the scheme
The VAT that you need to pay over to HMRC each quarter is simply the VAT percentage for the business sector in which you operate, multiplied by your VAT-inclusive turnover for that quarter.
The percentage is less than 20%; in this way, it includes an allowance for input VAT suffered.
If you fall within the definition of a limited-cost business (see below), your fixed-rate VAT percentage is 16.5%, regardless of the business sector in which you operate.
In the first year of the scheme, your fixed-rate percentage is reduced by 1%.
Example: VAT calculation under the flat rate scheme
Joel is a self-employed computer repair man. His annual turnover (excluding VAT) is around £90,000 (excluding VAT). To save work, he joined the flat rate scheme.
The fixed percentage for computer repair services is 10.5%. This is the percentage that Joel uses to calculate the VAT that he must pay over to HMRC each quarter. For the first year that he was in the scheme, his percentage (after allowing for the 1% discount) was 9.5%. He has been in the scheme for three years.
In the quarter to 31 August 2022, his VAT-inclusive turnover is £27,720.
The VAT that he must pay over to HMRC is simply £27,720 @ 10.5% = £2,910.60.
Limited cost business
Special rules apply to limited-cost businesses.
A business that is classed as a limited-cost business must pay 16.5% of its VAT-inclusive turnover to HMRC. If the business makes standard-rated supplies, this is equivalent to 19.8% of its VAT-exclusive turnover, leaving a very small margin (0.2% of turnover before VAT) to recover any input VAT incurred. This may mean that there is a cost attached in using the scheme.
A business is a limited-cost business if it spends less than 2% of its turnover on ‘relevant goods’. If the business spends more than 2% of its turnover on relevant goods but less than £1,000 a year (£250 per quarter), it will fall within the definition of a limited cost business.
The calculation should be performed for each VAT period – a business may be a limited-cost business in one quarter but not in the next. Where this varies, a fixed-rate percentage of 16.5% should be used where it ticks the ‘limited-cost business’ box, and the fixed-rate percentage for the business sector in which it operates should be used for quarters where it does not.
Relevant goods
Relevant goods are goods that are used exclusively for the purposes of the business but do not include:
- vehicle costs including fuel, unless your business operates in the transport sector using your own or a leased vehicle;
- food or drink for your staff;
- capital expenditure goods of any value;
- goods for resale, leasing, letting or hiring out where your main business activity does not ordinarily consist of selling, leasing, letting or hiring out such goods;
- goods that you intend to re-sell or hire out unless selling or letting is your main business activity;
- goods for disposal, such as promotional items, gifts or donations; and any services.
This means that accountancy and advertising costs, rent and digital downloads are not relevant goods as these are services. Stamps and postage costs also fall outside the definition of relevant goods, as these are payments for a service.
Examples of relevant goods cited in the Notice include:
- stationery and office supplies;
- gas and electricity used exclusively for the business;
- fuel for a taxi owned by a taxi firm;
- stock for a shop;
- cleaning products exclusively for the business;
- hair products to provide hairdressing services;
- software on a disk;
- food used in customers’ meals;
- goods brought by a subcontractor and separately itemised;
- goods brought into the UK if not otherwise excluded; and
- gifts brought into the UK without VAT being charged, if not otherwise excluded.
Consultancy businesses and those providing personal services are often limited-cost businesses.
Is the scheme for you?
The scheme will save you work as you do not need to keep detailed records showing VAT on sales and purchases. This alone may be a reason for joining it.
However, whether you will be better off or worse off than if you use standard accounting will depend on your circumstances. There is no excuse here for not crunching the numbers. Before joining the scheme, for a typical period, compare what you paid over to HMRC under standard accounting with what you would have paid had you used the scheme. If the amount is the same or less under the flat rate scheme, it is worth joining, especially as you will receive a 1% discount in the first year.
However, the scheme may not be for you if you are a limited-cost business that uses a lot of VAT-registered services, as the margin of recovery will not cover that which you have paid. This is because services are not relevant goods and are not taken into account in working out whether you meet the definition of a limited-cost trader.
If you normally receive a VAT repayment from HMRC, the flat rate scheme will not be for you either. This may be the case if you make zero-rated supplies (such as food) but incur input VAT. In this situation, you are better off remaining outside the scheme, despite the extra work, so that you can recover your net input VAT.
Practical tip
The VAT flat rate scheme will save work; but crunch the numbers before joining to see whether this comes at a cost.
