How does the Flat Rate Scheme work?

The scheme is an incentive provided by the government to small businesses to help them simplify their taxes. The company charges VAT on invoices at 20% but only needs to pay back HMRC at a lower percentage. This percentage depends on the business category under which the company trades. As an additional incentive, the Government gives a further 1% discount on the percentage in the first year.

As of 1 April 2017 the Government have introduced a new flat rate VAT concept of being a ‘limited cost trader’.  A business must determine each VAT period (usually quarterly) as to whether the definition of ‘limited cost trader’ is met.  If the business is a limited cost trader, a new percentage of 16.5% should be used instead of the business category rate.

A limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either:

• less than 2% of their VAT inclusive turnover in a prescribed accounting period
• greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000)

Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:

• capital expenditure
• food or drink for consumption by the flat rate business or its employees
• vehicles, vehicle parts and fuel (except where the business is one that carries out transport services – for example a taxi business – and uses its own or a leased vehicle to carry out those services)

Like standard VAT, the Flat Rate Scheme still requires you to complete a quarterly VAT return. Rather than accounting for the VAT on every payment, when you do your quarterly return you will only pay a single flat rate percentage on your turnover (inclusive of VAT) of each quarter. The VAT percentage you pay is considerably lower than that of the standard VAT rate, so your company keeps the difference as profit.

See the example below based on a Limited Company specialising in social work (not limited cost trader):

See the example below based on a Limited Company specialising in social work (limited cost trader):

What are the main advantages of registering for VAT and the Flat Rate Scheme?

One of the main advantages of registering for the Flat Rate Scheme is simplicity. Companies that have turnover over the VAT threshold currently will be required to register for VAT.  Once registered, there is the ability to earn additional revenue from VAT. It also reduces the amount of paperwork your company needs to handle as you are not submitting any of your input costs to HMRC. All you need to do is keep the receipts from your purchases. If you are a new business, using the Flat Rate Scheme in your first year, you receive a further 1% decrease on the overall percentage tax you pay each quarter.  The 1% first year discount also applies to ‘limited cost traders’.

Companies on the Flat Rate Scheme are unable to claim back any VAT on purchased goods and expenses for their business. However, the benefits of registering far outweigh this if you don’t buy many VAT inclusive goods and you can still reclaim VAT on capital asset purchases over £2,000, e.g. a PC. Providing all the capital purchases are on the same receipt such as a PC, printer and scanner you can claim the VAT back on these items. You cannot however buy a PC one month for £1,500 then a printer the next month for £300 and a scanner the month after for £200 and add them together, they must all be on the same receipt.

Can anyone join the Flat Rate Scheme?

If your company’s annual turnover excluding VAT will exceed £150,000 in your first year, you won’t be eligible to join the scheme. If you are already part of the scheme and your company’s annual turnover exceeds £230,000 of VAT inclusive revenue in subsequent years, you will have to leave the scheme