The VAT flat rate scheme can simplify VAT reporting for small businesses, saving time and effort. But is it the right choice for your business? Let’s explore how it works, the benefits, and whether it could save you money—or cost you more in the long run.
What Is the VAT Flat Rate Scheme?
Under the flat rate scheme, instead of calculating VAT on every transaction, businesses pay HMRC a set percentage of their VAT-inclusive turnover. The percentage depends on the type of business you run and whether you qualify as a limited cost business.
The main advantage? Less admin—you don’t need to record VAT on your purchases. However, it’s not always the cheapest option. For some businesses, the amount paid under the flat rate scheme could exceed what they’d pay using traditional VAT accounting.
Who Can Use the Scheme?
To be eligible, your business must:
- Be VAT registered.
- Expect a VAT taxable turnover of £150,000 or less in the next 12 months (this excludes VAT-exempt sales).
You can’t use the flat rate scheme if:
- You’ve left it within the last 12 months.
- You use a margin scheme, capital goods scheme, or the cash accounting scheme.
You must leave the scheme if:
- Your turnover exceeds £230,000 (including VAT) in the last 12 months or is expected to do so in the next 12 months.
- Your turnover in the next 30 days alone is expected to exceed £230,000 (including VAT).
How Does the Flat Rate Work?
Each business sector has its own flat rate percentage, which you can find on the Gov.uk website. If you’re in your first year of VAT registration, you’ll get a 1% discount on your flat rate.
Limited Cost Businesses
If your business spends less than:
- 2% of turnover on relevant goods, or
- £1,000 per year (£250 per quarter)
…then you’ll be classed as a limited cost business and pay a flat rate of 16.5%. This leaves very little room to reclaim VAT, as 16.5% of VAT-inclusive turnover is equivalent to 19.8% of VAT-exclusive turnover.
What Counts as ‘Relevant Goods’?
Only relevant goods are included when calculating whether you meet the 2% threshold. These are items used exclusively for business, but not all purchases count. Exclusions include:
- Services (e.g., accounting or advertising).
- Car fuel (unless you’re in the transport sector).
- Rent and other non-goods expenses.
If your business relies heavily on services or has low relevant goods costs, traditional VAT accounting may be more cost-effective.
Example: Photography Business
A photography business joins the flat rate scheme. In its first quarter:
- VAT-inclusive turnover: £24,000 (£20,000 + VAT).
- Relevant goods purchased: £1,250 (more than 2% of turnover).
The business is not a limited cost business. Its flat rate percentage is 11%, reduced to 10% in its first year.
VAT payable: £24,000 x 10% = £2,400
What About Capital Goods?
If you use the flat rate scheme, you usually can’t reclaim VAT on purchases. However, there’s an exception for capital goods costing more than £2,000 if you don’t intend to resell them.
Is the VAT Flat Rate Scheme Right for You?
The flat rate scheme offers simplicity, but it’s not always the most cost-effective option. Before joining, do the sums to see if it works for your business.
Need Help Deciding?
Not sure if the VAT flat rate scheme is right for your business? Contact Jon Davies Accountants for expert advice. We’ll help you weigh up the pros and cons to ensure your VAT strategy supports your business goals.
Let us take the hassle out of VAT so you can focus on growing your business!
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