What is the Flat Rate Scheme for VAT?

Flat rate VAT

In this video Stephen Edwards discusses what the flat rate scheme is and when it may be beneficial for you to explore it

It is amazing how many business owners know so little about the flat rate scheme for VAT. It is a scheme that can not only reduce the accounting burden for small businesses but also save them a fair few pennies in the process! So what is the flat rate scheme, who is eligible and what is the catch?

What is the Flat Rate Scheme

It is a scheme designed to reduce the time and accounting burden for small businesses who are VAT registered. It achieves this by removing a significant layer of the VAT return book-keeping process. Under the flat rate scheme you do not need to record the amount of VAT you have paid on your expenses, you simply record what you have paid in total. Subsequently you can’t claim the VAT back on your expenses.

The other major change is the way VAT is calculated on sales. Instead of paying over 20% of sales in VAT to HMRC (less the VAT you would normally be claiming back) you pay over a lower % on the gross sales figure.

An example would illustrate this best.

Standard VAT Calculation

Net sales £100
VAT due £20 (20%)
OR
Total sales inclusive £120
VAT due £20 (£120 x 1/6 or 20/120)
LESS
Costs £30 (Net)
VAT £6 (20%)
DUE TO HMRC = £20 less £6 = £14.

Calculation under the Flat Rate Scheme

Sales £100
VAT £20
Gross £120
VAT due = £120 x your flat rate (FR) %
So if we use 10% as an example
VAT due is £120 x 10% = £12.

Now, these figures have been plucked from thin air! I have purposely selected numbers demonstrating a situation where you are better off. The actual results are very sensitive to what your VAT claimable costs are, what your margins are and what the FR% is.

In case you are asking the question, yes you still charge VAT at standard rate to customers but only pay VAT over based on the total received (Inc VAT) x the FR%.

What is My Flat Rate % and Who Can Apply?

This is a percentage defined by HMRC depending on what sector your business is in. The full table of sectors and the relative FR% can be found HERE. In general the more VAT a business in a certain sector is likely to claim back, the lower the FR% will be. HMRC do this to try and put you in a similar position you would be if you were not using the flat rate scheme (the intention is to benefit from a simpler book-keeping process).

To be eligible for the scheme your estimated VAT taxable turnover – excluding VAT – in the next year will be £150,000 or less. Your VAT taxable turnover is the total of everything that you sell during the year that is liable for VAT. It includes standard, reduced rate or zero rate sales or other supplies. It excludes the actual VAT that you charge, VAT exempt sales and sales of any capital assets.

Other Points

Generally you don’t reclaim any of the VAT that you pay on purchases, although you may be able to claim back the VAT on capital assets worth more than £2,000 – see the section in this guide on claiming back VAT on capital assets for the rules and restrictions.

Once you join the scheme you can stay in it until your total business income is more than £230,000.

Tax

There will be an effect to the tax you or the business pays as the different basis of accounting will effect the bottom line profit. EG – Instead of recording expenses in the accounts net/excluding VAT, they will now be inclusive of VAT. The tax effect of this is a saving on the increase. If £100 of net expenses is now recorded as £120 under the FR scheme you have an extra £20 of costs to claim which will lower the overall tax liability.

The downside to this is that it works both ways! As you pay less VAT on sales under the FR scheme, the bottom line will be increased. EG If £100 of net sales was recorded pre FR scheme then using the figures in my previous example £108 will now be recorded (£120- £12). This means you are paying tax on an extra £8 of income…

CONCLUSION

Not all businesses are better off using the FR scheme. However I have come across many who save a few hundred to a few thousand a year by adopting it from day one. A number of factors come into play to forecast and calculate the overall position and whether a business is better off. The main thing that I want the readers of this blog to take away is that every business who is eligible to apply for the scheme SHOULD assess their position to estimate the potential saving (or not).

Any accountant worth their salt should be making VAT registered clients aware of the scheme early doors. If not then potentially thousands of pounds could have been paid to HMRC instead of keeping it in your pocket.
If you feel that you may be eligible for the scheme I am more than happy to do a free review of your last VAT return to ascertain whether savings could be made.

For more guidance on the Flat rate Scheme, visit the HMRC website.