The flat rate scheme is one of the schemes that simplifies accounting for VAT for business or traders registered for VAT. In this blog post, let’s look at how the scheme works.
Normally, traders account for VAT every quarter by declaring output tax on the VAT return and offsetting any input tax paid during the quarter. The net amount is then paid to or reclaimed from HMRC. For instance, consider a scenario where a trader made sales of £20,000 plus VAT and purchase of £5,000 plus VAT. The VAT return would look something like this
| Description | Amount (£) |
|---|---|
| Box 1 – VAT due on sales (£20,000 × 20%) | 4,000 |
| Box 4 – VAT reclaimed on purchases (£10,000 × 20%) | 1,000 |
| Net VAT to be paid to HMRC | 3,000 |
The business owes HMRC £4,000 but can offset the £1,000 VAT it has paid on purchases. In effect, the business needs to pay £3,000 to HMRC.
Even though the business owed £4,000 to HMRC, it effectively paid £3,000. In other words, from the 20% VAT that was owed, £4k in this example, only £3k was paid over. So effectively, the net VAT paid over to HMRC is 15% of sales (£20k x 15% = £3k). Let’s revisit this later.
Basics of the FRS
Under the flat rate scheme, this process is simplified whereby businesses or traders take the total taxable turnover, apply a flat rate to work out the total output VAT due to HMRC. This saves traders time and costs in preparing their VAT return. This is aimed at newly established businesses to save them key resources which could be employed elsewhere in the business.
For instance, let’s say a newly set up accountancy firm with a flat rate of 14.5% makes £25,000 in a given quarter. The output VAT due will simply be £25,000 into 14.5% = £3,625.
First-year discount of 1%
HMRC has introduced a 1% discount for traders in the first year of their VAT registration. This is a small gift from HMRC as newly registered business often struggle in maintaining proper records needed for VAT. To help ease this burden, HMRC offers a 1% discount which reduces the flat rate by 1% point.
So, for a newly registered accountancy firm, the flat rate would be reduced to 13.5% from 14.5%. This would save £250 in VAT payable to HMRC, in effect 1% of the taxable turnover.
How to work out the flat rate?
HMRC has a published a list of flat rates according to industry types. Business can look up the applicable flat rate online by clicking on the following link.
https://www.gov.uk/vat-flat-rate-scheme/how-much-you-pay
Limited cost business
Businesses with very few costs are classed as Limited cost businesses. There is a special rate of 16.5% applicable to such businesses.
You can be classed as a limited cost business, if your cost of goods is:
- Less than 2% of the turnover, or
- More than 2% of the turnover but less than £1,000
You need to pay close attention to what counts as cost of goods or relevant goods. The cost of goods includes moveable items or materials purchased and use exclusively for your business. In effect, the relevant goods are goods primarily purchased for use in the business and do not include services or capital items. The following is a list of costs not considered as cost of goods.
- Any services (any service which is not good)
- Travel and accommodation costs
- Food and drink for yourself or your staff
- Vehicle costs unless operating in the transport sector
- Rent, interest, phone bills and accountancy fees
- Gifts, promotional items and donations
- Goods for resell or hire out, unless this is your line of trader
- Training and memberships
- Capital items
Capital items costing £2,000 or more
The only exception under the flat rate scheme is the purchase of capital items like mobile phones, office equipment, etc.
If a business operating under the flat rate scheme, purchases a capital asset costing £2,000 or more, including VAT, then it can reclaim the VAT paid on this purchase on the VAT return. This would be treated outside the flat rate scheme.
On the VAT return, the input tax paid on the purchase of the capital asset, costing at least £2,000, would be claimed in box 4 of the VAT return.
Let’s say a trader purchases office equipment costing £3,000 including VAT. The trader can reclaim £500 as input tax in box 4 of the VAT return. Upon subsequent disposal of the equipment, the trader will need to account for VAT on the sale proceeds.
Conditions for joining
VAT registered businesses can join the flat rate scheme provided their Vatable turnover is £150,000 or less (excluding VAT) in the next 12 months. In other words, the net turnover for the next 12 months should be less then £150,000.
When to leave the scheme
Traders using the flat rate scheme must leave the scheme if:
- Turnover including VAT in the next 12 months is expected to be more than £230,000
- On the anniversary of joining the scheme, the turnover in the last 12 months was more than £230,000 (including VAT)
- Turnover in the next 30 days is expected to be more than £230,000 including VAT.
