Simplifying VAT: The VAT Flat Rate Scheme

Value Added Tax (VAT) can be a confusing matter at the best of times for self-employed people, but understandably it can be something of an afterthought. When you first start out in self-employment your main focus will be on getting established and business growth and you will likely be under the £90,000 turnover threshold when VAT registration becomes mandatory.

You could of course register voluntarily if you’re under the threshold but you might be unsure if this is the best course of action or might be wary of the complexity of the VAT returns process and the associated admin time drain, as well as potential penalties for non-compliance.

There are, of course, both benefits and challenges of being VAT registered. One of the main challenges is the administrative burden that comes with completing your quarterly VAT returns.

The majority of VAT registered businesses operate through the VAT standard rate scheme, but there are some drawbacks to it from the perspective of self-employed people and small businesses. Before exploring the VAT flat rate scheme, let’s get a definition-check on the standard rate scheme.

What is the Standard Rate Scheme?

When you use the VAT standard rate scheme, your VAT liability is the difference between your quarterly input VAT and output VAT. Output VAT is the amount of VAT that you charge on your sales and input VAT is the amount of VAT that you pay on purchases you make, with VAT levied at 20% on all transactions.

On a quarterly basis you must add up the output VAT that you’ve charged on your sales and subtract the total amount of input VAT you’ve paid on purchases. The resulting figure is your VAT liability to be paid to HMRC if output VAT exceeds input VAT. If input VAT exceeds output VAT, the amount will be refunded back to you by HMRC. This is known as a repayment return.

Self-employed people are generally very busy and not blessed with a lot of time to put into administrative tasks. Calculating your VAT returns and ensuring compliance on the VAT standard rate scheme is no simple task. The calculations required for the VAT standard rate scheme can be onerous and complex and can be a big administrative burden, and this is a key reason why the VAT flat rate scheme was introduced in 2002.

What is the VAT Flat Rate Scheme?

One of the main drivers behind the VAT flat rate scheme was to make VAT easier for self-employed people and small businesses by simplifying and streamlining the process of charging and reclaiming VAT.

Here’s how the flat rate scheme differs from standard rate:

  • A fixed rate VAT percentage is applied to your VAT-able turnover to calculate your VAT liability
  • The difference between the VAT you pay to HMRC and the VAT charged to your customers is additional turnover for your business
  • You can’t, however, reclaim VAT on your business costs, except for purchases of capital assets costing £2,000 or more and some pre-registration expenses
  • The fixed rate VAT percentage on the flat rate scheme is discounted by 1% for your first year of registration

If your business is VAT registered and your VAT-taxable turnover is not expected to exceed £150,000 in the next 12 months you are eligible to join the VAT flat rate scheme. If your VAT-inclusive turnover exceeds £230,000 over a 12 month period, or if you expect it to exceed this amount, you must leave the flat rate scheme.

With the flat rate scheme, the VAT rate is dependent on your business sector with rates varying between 4% and 14.5% except for limited cost traders.

Limited Cost Traders and The VAT Flat Rate Scheme

The flat rate scheme can be beneficial if your business is classed as a limited cost trader The VAT flat rate scheme works slightly differently if your company expenditure on goods is relatively small and you’re classed as a limited cost trader if you meet the below criteria:

  • You spend less than 2% of your VAT-inclusive turnover on goods annually
  • You spend less than £1,000 annually on goods if your costs are higher than 2%

Capital expenditure and items including fuel, vehicles, vehicle parts and drinks or food for your business or staff are excluded from this expenditure.

As a limited cost trader you are subject to a special 16.5% VAT rate under the Flat Rate Scheme. Generally limited cost traders are businesses that offer a more labour-oriented service rather than professional services or retailers. It’s important that limited cost traders recheck their eligibility annually against the above criteria.

What are the Advantages of the VAT Flat Rate Scheme?

Due to the way your VAT liability is calculated under the flat rate scheme, you will spend much less time on VAT accounting due to applying VAT against your VAT-inclusive turnover rather than the VAT charged on your sales and paid on your purchases.

You also get a 1% reduction in the VAT rate for your first year of registration on the scheme and also benefit from better financial clarity as you will know exactly what percentage of your turnover will have to be paid to HMRC, and this clarity also brings peace of mind as its easier to remain compliant which means less chance of penalties from HMRC.

VAT Accounting with Gorilla

Self-employed people and small business owners usually have many questions regarding VAT. Should you register voluntarily if turnover is below the mandatory registration threshold? What are the benefits and drawbacks of doing so?  Which VAT scheme is the right one for your business?

Deciding which VAT scheme is the best fit for you involves consideration of various factors such as your business turnover, the amount of VAT you could reclaim on the standard rate scheme, your expenditure on goods for your business, which sector or industry you trade in and how much capacity you have for admin. You should also use a comparison of what your VAT liability would be on the flat rate Scheme against versus standard rate.

This is where Gorilla Accounting comes in. As a Gorilla Accounting client you will work with your own dedicated accountant who will be able to guide you through the VAT landscape. We often recommend that our clients register for VAT even if turnover is below the mandatory registration threshold, but the advice and guidance you receive is always based on your specific circumstances and business goals.

If you do register for VAT, we’ll make sure you register on the right VAT scheme for you as well as ensuring that all your business and personal accounting needs are expertly handled with a same working day response guaranteed on all your queries.

Every quarter your dedicated accountant will calculate your VAT liability which is then reported to HMRC on your VAT Return and submitted through market-leading FreeAgent accounting software which you receive inclusive in your monthly fee as a Gorilla Accounting client.

Our expert VAT accountants are on hand to advise you so if you have any queries about the VAT flat rate scheme, VAT in general or our accounting service, please call us on 0330 024 0406 or request a call back today.