Xtract Accounting, the small business Accountants for Directors and Limited Companies, explains how the VAT Flat Rate Scheme works and why making use of it could benefit your business.
Under the standard VAT rules, a VAT registered business must account for VAT on their sales, known as Output VAT, and can also reclaim any VAT they have paid on purchases from other VAT registered businesses (i.e. from suppliers, etc.), known as Input VAT.
Figures for VAT charged and paid must be reported to HM Revenue and Customs (HMRC) on a VAT Return, which is normally submitted every three months.
If the business has charged more VAT than what it has paid, the difference will result in a payment being due to HMRC. Conversely, if the business has paid more in VAT than what it has charged, the difference can be reclaimed from HMRC.
However, the VAT Flat Rate Scheme works differently, and that is what we will look at in this blog.
What is the VAT Flat Rate Scheme?
As explained above, businesses normally pay or reclaim VAT based on the difference between the VAT charged on sales and the VAT paid on purchases.
The VAT Flat Rate Scheme was introduced to reduce the administrative burden on small businesses allowing them to pay HMRC a fixed rate of VAT. This means businesses can keep the monetary difference between what they charge to customers and what they pay to HMRC in VAT.
The only downside is that the business cannot reclaim any Input VAT which they have paid (e.g. to suppliers), unless they have purchased certain capital assets costing more than £2,000. (for an explanation, see VAT Notice 733).
Which businesses can join the VAT Flat Rate Scheme?
Businesses must register for VAT if their VAT taxable turnover (i.e. the total of all sales that are not VAT exempt) exceed £85,000 (2020/21 tax year), known as the ‘VAT Threshold’. Businesses with VAT taxable turnover under this figure can voluntarily register for VAT if they want to.
The VAT Flat Rate Scheme also has a separate threshold of £150,000. VAT registered businesses can only opt to join the scheme if they do not expect their taxable turnover to exceed £150,000 (excluding VAT) over the next 12 months.
The VAT Flat Rate Scheme is entirely optional, regardless of whether the business is obliged to register for VAT or not.
When does a business have to leave the VAT Flat Rate Scheme?
A VAT registered business must leave the VAT Flat Rate Scheme if:
They are no longer eligible to be in it (see below).
On the anniversary of joining the scheme, their taxable turnover in the last 12 months exceeded £230,000 (including VAT).
They expect their taxable turnover to exceed £230,000 (including VAT) in the next 12 months.
The expect their total income in the next 30 days alone to exceed £230,000 (including VAT).
Which businesses cannot join the VAT Flat Rate Scheme?
Businesses are not eligible to join the VAT Flat Rate Scheme if:
They left the scheme within the previous 12 months.
They committed a VAT offence in the previous 12 months (e.g. VAT evasion).
They joined (or were eligible to join) a VAT group in the previous 24 months.
They registered for VAT as a business division in the previous 24 months.
Their business is ‘closely associated’ with another business (for an explanation see VAT Notice 733).
They have joined a margin or capital goods VAT scheme.
Furthermore, businesses cannot use the VAT Flat Rate Scheme with the Cash Accounting Scheme.
How does a business Opt-in or Opt-out of the VAT Flat Rate Scheme?
Businesses can opt-in to use the scheme when they submit their VAT registration online. Alternatively, they can complete form VAT600FRS and email it to frsapplications.vrs@hmrc.gsi.gov.uk (or send it by post using the address on the form).
If a business wishes to join both the VAT Flat Rate Scheme and the Annual Accounting Scheme, they can apply using the form VAT600AA/FRS.
When a business wants to leave the scheme, or it is required to do so, they must write to HMRC.
How does a business know what Flat Rate applies to them?
There are different Flat Rate’s for different types of business. For example, the Flat Rate for a Computer Repair firm is 10.5%, but for a Printing firm it is 8.5%. For a full list of the current Flat Rate’s according to business type, see Gov.uk.
Businesses who are in their first year of VAT Registration can apply a 1% discount to their Flat rate, thus increasing their cashflow benefit during this time.
How does a business calculate the VAT payable under the VAT Flat Rate Scheme?
When calculating the amount of VAT payable to HMRC, the business should multiply the relevant flat rate percentage by the VAT Inclusive turnover, this being the value of all sales (including all exempt sales) including the VAT charged.
For example, a Printing firm who charges a total of £3,000 to their clients (i.e. £2,500 plus VAT at 20%), would multiply £3,000 by the flat rate which applies to Printing firms (8.5%). So the amount payable would be £255.
What are ‘Limited Cost’ businesses?
For many years, businesses in certain industries and in certain circumstances had been able to take advantage of significant monetary gains by using the VAT Flat Rate Scheme. This loophole was closed by HMRC in April 2017, with the introduction of the ‘Limited Cost Trader’ legislation.
HMRC says a ‘Limited Cost Trader’ is a business whose spend on goods, including VAT, in a quarter is:
Less than 2% of its VAT-inclusive sales for that quarter, or
More than 2% of its VAT-inclusive sales for the quarter, but less than £250.
The legislation requires Limited Cost Trader’s to apply a Flat Rate of 16.5%, which could in some cases, result in the business paying more VAT to HMRC than what it had done if it were using the standard VAT rules.
A business who operates VAT under the VAT Flat Rate Scheme rules should check whether it is a ‘Limited Cost Trader’ every VAT period, whether than be monthly, quarterly, or annually.
For more information, see VAT Notice 733.
To summarise, what are the Pros and Cons of the VAT Flat Rate Scheme?
Pros:
VAT Returns are generally more straight forward to complete.
Less administrative burden on businesses.
1% flat rate discount (for 12 months) for newly VAT registered businesses.
Depending on individual circumstances, it can save businesses money.
Cons:
Input VAT cannot be reclaimed on purchases (except on certain capital assets).
Income that would normally be Exempt (e.g. residential rent) is taxable under the VAT Flat Rate rules.
Identifying the correct VAT Flat Rate based on business type can be challenging.
Monitoring of taxable turnover required, as well as ‘Limited Cost Trader’ rules.
About the Author of this Blog post…
Hi, my name is Gordon Roe and I am the Founder and Managing Director of Xtract Accounting. Having worked in an accountancy practice setting for well over a decade, I had become accustomed to the same annual routine for clients - Books in… Analyse… Queries out… Answers in… Finalise… Accounts and Tax Advice out.
Then, in 2020 I realised I could use advancements in technology and software to significantly improve the relationship between accountant and client, and at the same time, provide an insightful and real-time tax advice service. After all, that is what the modern client expects and deserves!
And so, Xtract Accounting was born…
Xtract Accounting are online accountants based in Lincolnshire, who offer proactive small business accountancy services exclusively to Directors and Owner Managed, Micro and SME Limited Companies throughout the UK.
We specialise in helping Directors Xtract more out for the work they put in!
Our monthly 'FD' service with fixed monthly fees, sees us take on the more proactive role of Finance Director for your business, and offers a plethora of benefits including:
Inclusive accounting software provided by FreeAgent,
Your very own dedicated accountant,
Regular insights into how to maximise your tax efficient (or even tax free!) income,
Jargon-free telephone and email support,
Plus, much, much more!
With Xtract Accounting, you can be sure your accounts and tax will be kept up-to-date and organised.
Find out more about us or connect with us on Social Media (below)