What is the Flat Rate VAT Scheme?
The Flat Rate VAT Scheme lets small VAT-registered businesses pay HMRC a fixed percentage of their VAT-inclusive turnover instead of working out VAT on every sale and purchase.
What the Flat Rate VAT Scheme means
Under normal VAT accounting, you pay HMRC the VAT you charge customers (output VAT) minus the VAT on your business costs (input VAT). On the Flat Rate Scheme, you still charge customers 20%, but you pay HMRC a fixed percentage of your total VAT-inclusive turnover. You generally cannot reclaim VAT on purchases, apart from single capital items costing £2,000 or more including VAT.
The percentage depends on your trade sector, and there is a 1% discount in your first year of VAT registration. You can join if you expect taxable turnover of £150,000 or less excluding VAT in the next 12 months, and must leave if total income goes over £230,000.
The limited cost trader rule
Businesses that spend very little on goods are classed as limited cost traders and must use a rate of 16.5%. You are a limited cost trader if your spending on goods is less than 2% of your VAT-inclusive turnover, or less than £1,000 a year. Services, rent, fuel and capital items do not count as goods. This catches many consultants and contractors.
Example
An IT consultant invoices £100,000 plus VAT a year, so receives £120,000 in total. Costs are mostly software and travel, so they are a limited cost trader.
| Standard VAT | Flat Rate (16.5%) | |
|---|---|---|
| VAT charged to clients | £20,000 | £20,000 |
| VAT reclaimed on costs | (£800) | Not available |
| Paid to HMRC | £19,200 | £19,800 |
Here the scheme costs £600 more than standard accounting. A consultant who was not a limited cost trader, with a sector rate of 14.5%, would pay £17,400 and keep £1,800 more.
Why it matters for your business
The Flat Rate Scheme can save time and sometimes money, but only if your sector rate is low compared with your real VAT position. It rarely suits businesses with high VAT-able costs or that sell mainly zero-rated goods. Since the limited cost trader rule arrived, many service businesses have found standard VAT accounting better. Review it each year, because your costs and turnover change.
Flat Rate Scheme returns still go through Making Tax Digital software, so it does not remove the need for digital records.
Common questions
It depends on your sector rate and costs. If you buy few goods you will probably be a limited cost trader at 16.5%, which often costs more than standard VAT. Businesses with a low sector rate and few VAT-able costs can still benefit. Run both calculations before joining.
Generally no. The exception is a single capital asset costing £2,000 or more including VAT, such as equipment, where you can reclaim the VAT through your return. Everyday purchases such as stock, software and fuel give no VAT recovery on the scheme, which is why it suits low-cost businesses best.