Flat Rate VAT Scheme for Contractors

The original aim of the VAT Flat Rate Scheme was to simplify the process of charging and reclaiming VAT for smaller businesses. It allows eligible businesses to calculate the VAT liability by applying a fixed rate percentage to their gross turnover.

To be eligible for the Flat Rate VAT Scheme, you should expect your VAT taxable turnover to not exceed £150,000 in the next 12 months. You must leave the scheme if your VAT inclusive turnover in the last 12 months was more than £230,000 or if you expect it to be in the next 12 months.

Some of the differences with the VAT Flat Rate Scheme compared to using standard rate VAT are as follows:

You apply a fixed rate percentage, depending on the type of business, to the gross turnover to calculate the VAT liability.
The difference between what you pay to HMRC in VAT and what you charge your customers is additional turnover for the business.
You can’t reclaim VAT on your business costs, except for certain capital assets that cost £2,000 or more.
You receive a 1% discount to the fixed rate percentage for the first year of VAT registration.

You may be classed as a Limited Cost Trader if your business expenditure on goods is either:

• Less than 2% of your VAT inclusive turnover.
• Less than £1,000 per annum (if your costs are higher than 2%).

If you are classed as a Limited Cost Trader, then the fixed rate percentage to use will be 16.5% (15.5% in the first year of VAT registration).

To calculate the VAT liability using the standard rate VAT, you work out the difference between the input VAT and the output VAT during a quarter.

Output VAT is the amount of VAT that you charge on your sales. Input VAT is the amount of VAT that your suppliers charge you.

Every quarter, you should add up all of the output VAT you have charged and then subtract the total amount of input VAT paid on your purchases. This then leaves you with either a balance that needs to be paid or an amount that you will be refunded by HMRC.

The Flat Rate Scheme does have benefits but whether the scheme is best for you can depend on the industry that you work in, the level of company turnover, the amount you spend on goods used by the business and the amount of VAT that could be reclaimed using the standard rate scheme. It is worthwhile comparing what the business would pay using the Flat-Rate Scheme against using standard rate VAT.