The VAT flat rate scheme is designed to simplify VAT reporting for smaller VAT-registered businesses. Instead of calculating the difference between the VAT charged to customers and the VAT paid on business expenses, businesses in the scheme pay a fixed percentage of their VAT-inclusive turnover directly to HMRC. This percentage varies depending on the business sector and factors in VAT incurred on purchases, as businesses under this scheme cannot claim VAT back on these expenses. Additionally, the record-keeping requirements are less demanding.

Eligibility Criteria

This scheme is available to traders who are either eligible for VAT registration or already VAT-registered, with an annual turnover (excluding VAT) of no more than £150,000. The business must also be independent, with no ties to other businesses.

Once enrolled, a trader can stay in the scheme as long as their annual turnover does not exceed £230,000. If the turnover temporarily surpasses this limit, HMRC may allow the trader to remain in the scheme if they expect the turnover to fall below £191,500 in the next 12 months.

Businesses using other VAT schemes cannot switch to the flat rate scheme. If a trader exits the scheme, they must wait 12 months before rejoining.

Traders can join the scheme online during VAT registration or, if already VAT-registered, by submitting form VAT600FRS.

Flat Rate Percentage

The flat rate percentage, which determines the VAT payable to HMRC, depends on the business sector. The specific percentages are available on the Gov.uk website.

A flat rate of 16.5% applies to ‘limited-cost businesses,’ regardless of their sector. A business is considered limited-cost if the cost of goods is less than 2% of turnover or less than £1,000 (whichever is higher). Services are not counted in this calculation.

New businesses in the scheme receive a 1% discount on their flat rate percentage for the first year.

How to Calculate VAT

To calculate the VAT due, apply the flat rate percentage to the VAT-inclusive turnover for the quarter.

Example 1:
Diana owns a ladies’ clothing store. Her VAT-inclusive turnover for the quarter ending 31 July 2024 is £36,000. With a flat rate percentage of 7.5% (for retailing not listed elsewhere), she owes £2,700 to HMRC.

Example 2:
Eve is a bookkeeper with a VAT-inclusive turnover of £12,000 for the quarter ending 31 July 2024, and relevant costs of £175. Since her costs are less than 2% of her turnover, she is classified as a limited-cost business. Her VAT for the quarter is calculated using the 16.5% flat rate, resulting in a payment of £1,980 to HMRC.

Is the Scheme Beneficial?

While the scheme simplifies bookkeeping by reducing the need for detailed records of sales and purchases, it may not always save money. Although flat rate percentages are below the standard 20% VAT rate, businesses should compare the potential VAT payments under this scheme with those under the traditional method to determine which is more beneficial. Limited-cost traders, in particular, may find the scheme less advantageous, as the 16.5% rate on VAT-inclusive turnover equates to 19.8% on VAT-exclusive turnover, leaving little room to recover VAT on purchases. For businesses with significant VAT expenses on services, the flat rate scheme might result in higher costs.

It’s essential to run the numbers before deciding.