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There are numerous ways to be more tax efficient as a limited company, including registering for the Flat Rate VAT Scheme. But before you do so, you should understand exactly what it is, as well as determine whether it’s the best method to reduce your tax liability.

To help you get to grips with VAT, we’ve pulled together all the essential information that you’ll need to be aware of.

When to register for VAT

Registering for VAT isn’t always a choice – if your limited company’s annual turnover is over the £85,000 threshold, then it’s a legal requirement unless all of your income is outside the scope of VAT or exempt. It’s best to register when your business’ income is approaching the threshold, as if you don’t do so within 30 days of surpassing it, then it’s likely that HMRC will fine you.

Early VAT registration is also beneficial to your limited company, as you can reclaim any VAT charged on purchases you’ve made – this is known as input VAT. Additionally, some clients won’t actually work with those that aren’t VAT registered, so there may be a wider variety of contract opportunities available to you as well.

You’ll need to charge for the VAT on any invoices you issue – this is classed as output VAT. 

The available VAT schemes

There are a few different VAT schemes for you to pick from. You can calculate the VAT liability using a standard rate, where you total up your output VAT for the quarterly VAT return, and subtract the input VAT. You should then have a figure that will either need to be paid to HMRC or refunded by them.

The Annual Accounting VAT Scheme is similar to this, but you’ll only be required to report VAT on a yearly basis. You would make payments to HMRC, in advance of the return being submitted which are estimates of the VAT owed and a balancing payment on the due date of the return. At the end of the year, as with the standard rate, you might be eligible for a refund or need to make another payment to HMRC.

The Cash Accounting Scheme can prove useful if your clients are slow to pay invoices, as you only account for VAT once it’s been paid to you. You’ll need to submit quarterly returns with this method, and you won’t be able to reclaim any VAT on purchases made until you’ve paid them in full – this might not be ideal if you frequently use credit. This scheme, as well as the Annual Accounting VAT Scheme, isn’t available for limited companies with a turnover of over £1.35m.

There’s also the Flat Rate Scheme, which can be used by limited companies whose annual taxable turnover is less than £150,000.

Flat Rate Scheme

This scheme is generally seen as the most beneficial one available for limited company contractors. This is because it simplifies how you charge and reclaim VAT by using a flat rate percentage to your limited company’s gross turnover. The fixed rate you apply will depend on whether you’re a ‘limited cost trader’, as well as your business type.

Your limited company will be classed as a limited cost trader if your goods cost either below 2% of your turnover or £1,000 a year. You’ll pay a higher rate of 16.5% if this is the case. If you don’t come under this classification, HMRC has a complete list of the types of businesses and the corresponding current flat rates for each.

Using the fixed rate for your limited company, you multiply it by your VAT inclusive turnover (this includes business earnings, along with the VAT paid on it), and you keep the difference between the amount charged to customers and paid to HMRC. For the first year under this scheme, you are eligible for a 1% discount on the flat rate. 

It’s important to note that you can’t reclaim any VAT on business costs with the Flat Rate Scheme – though specific capital assets costing over £2,000 are an exception. Also, if your VAT inclusive turnover will reach more than £230,000 over a twelve month period, you’ll need to leave the scheme.

Which scheme is best for you?

Whilst the Flat Rate Scheme has proven to be the most tax efficient for many, it shouldn’t be assumed that this will be the case for every contractor. A variety of factors, including your industry, annual turnover and the amount your limited company spends on goods, will affect whether this is the best method to reduce your tax liability. You should also compare whether a higher level of VAT could be reclaimed using the standard rate instead.

Figuring out the most appropriate scheme for your limited company can prove troublesome if you’re not an accountancy expert. A specialist contractor accountant can decipher this for you, along with establishing whether you’re a limited cost trader or not.

Get expert VAT guidance

An accountant can assist you with more than just deciding the best VAT scheme for you – at Gorilla Accounting we can also help with preparing your VAT returns. You simply submit the returns via FreeAgent and pay the VAT owed, and we will sort out the numbers. You can even pay your VAT using a direct debit to further minimise worry and stress.

We can help with your limited company’s other accounting and tax duties too, including submitting the Self Assessment tax return and reviewing your bookkeeping data. For more information about what we can do for your limited company, get in touch with our team today.