The VAT Flat Rate Scheme: Simpler, but Worth It?

You charge 20% and hand over less. That was the appeal — until the limited cost trader rules removed the benefit for most service businesses.

Illustration of the UK VAT Flat Rate Scheme and the limited cost trader rate

The Flat Rate Scheme is usually explained as a way to keep some of the VAT you charge. That was true for a lot of businesses once. For most service businesses it stopped being true when the limited cost trader rules arrived, and the scheme is still being recommended to people it no longer suits.

The mechanics

You charge customers VAT as normal — 20% on standard-rated sales. Instead of paying HMRC the difference between the VAT you charged and the VAT you were charged, you pay a flat percentage of your gross turnover, VAT included.

In exchange, you generally cannot reclaim input VAT on purchases. There is an exception for capital assets costing £2,000 or more including VAT, bought as a single purchase.

There is also a 1% discount in your first year of VAT registration, which is genuinely worth having if the scheme suits you anyway.

Why the sums surprise people

The flat percentage applies to the gross figure, not the net. A 14.5% rate sounds like a large saving against 20%, but on £120,000 gross that is £17,400 — against £20,000 of output VAT on £100,000 net. The saving is real but smaller than the headline suggests, and it exists only if you had little input VAT to reclaim in the first place.

The limited cost trader rule

This is the part that decides it for most people. If your spending on goods is less than 2% of turnover, or less than £1,000 a year, you are a limited cost trader and must use a flat rate of 16.5% whatever your sector.

Applied to gross turnover, 16.5% is equivalent to just under 20% of the net figure. There is almost nothing left. And you still cannot reclaim input VAT.

Services do not count as goods for this test, and neither do fuel for a vehicle in most cases, capital items, or food and drink. A consultant, a designer or a contractor with a laptop and a phone contract is very likely a limited cost trader.

When it still works

You buy a reasonable volume of physical goods — over 2% of turnover
Your genuine input VAT is low relative to what you charge
You value the simplicity and the reduced bookkeeping
You are in your first year and the 1% discount tips it

Decide on your own figures

Take a full year of real numbers and calculate both ways. It is a twenty-minute job and it settles the question definitively for your business rather than in general. If you would like us to run it, we will tell you which way it comes out and by how much — including when the answer is that you should stay on standard VAT accounting.

Getting help with this

AJH Accountants handles vat for clients across the UK. We deal with HMRC, tell you what you can claim, and file on time, so nothing rests on you remembering a deadline. See how the service works, ask for a fixed-fee quote, or call the office on 01204 840303.

Originally published at ajhaccountant.co.uk/blog/vat-flat-rate-scheme-worth-it.