Is the VAT Flat Rate Scheme right for your business?
FRS (Flat rate scheme)
An optional VAT scheme is available to all small businesses with a VAT exclusive annual taxable turnover of up to £150,000. This requirement applies at the point of entry into the scheme. Companies should check their turnover on each anniversary of joining the scheme, and if the turnover exceeds £230,000 (VAT inclusive), they must usually leave the scheme.
A business that joins the scheme avoids accounting internally for input VAT on all purchases and supplies. Instead, it calculates its net liability by applying a flat rate percentage to the VAT inclusive turnover. The flat rate percentage depends on the trade sector a business falls for the scheme. Overall applicable percentages range from 4% to 14.5%.
Under the FRS, businesses can:
- Continue to charge their customers the standard rate of 20% for the supplies (i.e. not the flat rate percentage) on all taxable supplies of goods or services.
- Businesses do not have to record all the sale details and purchase invoices received to calculate the amount of VAT they must pay to HMRC.
The basic principle of the FRS is that the business applies a fixed percentage to its gross income, and that is the VAT payable at the end of each quarter. The rate of percentage depends on the relevant FRS business category. A business claims input tax only if it buys capital goods ( Such as computer equipment, plant and machinery etc.) costing more than £2000, including VAT.
The applicable percentage is also applied to zero-rated and exempt sales, including VAT. The relevant percentage is also used to zero-rated and exempt sales and those subject to 5% or 20% VAT. But income outside the VAT scope, for example, most services provided to overseas business customers, are excluded. The scheme can be used by any business with annual taxable sales of £150,000 or less, excluding VAT.
Who can and cannot join the scheme?
You will be eligible to join the VAT FRS if:
- You’re eligible to be registered for VAT
- Your taxable turnover (excluding VAT) in the next year will be £150,000 or less
- Your business is not ‘associated’ with another business that cannot join the FRS
You are ineligible to join the VAT Flat Rate Scheme if:
- You’ve been in the scheme before and left it less than 12 months ago (you need to wait until a year has gone by before you can re-join)
- You’ve been guilty of a VAT offence or charged a penalty for evading VAT within the last 12 months
- You use a second-hand margin scheme
- You are or have been within the last 24 months, a member or potential member of a VAT group, or registered for VAT as a division of a more significant business
- Your business is closely associated with another business
When to consider avoiding the VAT Flat Rate Scheme?
Because flat rate taxable sales include VAT-exempt sales, it’s probably not a good idea to join the scheme if you make a lot of exempt sales, as you might end up paying more in VAT.
If you make a lot of zero-rated sales or buy standard-rated goods and services, joining the scheme will likely cost you more in VAT. Businesses not on the Flat Rate Scheme would usually get repayment from HMRC each quarter which they would lose if they joined the scheme.
The flat rate you use depends on the business sector that you belong to. The correct sector is the one that most closely describes what your business will be doing in the coming year. The flat rate has changed since 1 April 2017 if you’re a limited cost business.
What is limited cost business:
Your business will be classed as a ‘limited cost business’ if your goods/services cost less than either:
- 2% of your turnover
- £1,000 a year (if your costs are more than 2%)
This means you pay a higher rate of 16.5%. You can calculate if you need to pay the higher rate and determine which goods count as costs.
If you are not a limited cost business, you use your business type to work out your flat rate.
For example, if your turnover is £150,000, you need a minimum of £3,000 direct cost to use the trade rate suggested by HMRC.
Steps to consider:
|Step||What you need to do||Please remember|
|1||See if your business will be a limited cost business.||If you’re a limited cost business, your flat rate percentage will be 16.5% regardless of your sector.|
|2||If you’re not a limited cost business, a list of businesses is available||The descriptions of the sectors are not technical and use ordinary English. They are what HMRC reasonably believes relate to business types. So if there is a match or a close fit, you can use that sector.|
|3||Check to make sure your business is not mentioned in a composite sector||Some of the sectors refer to more than one business type.|
|4||If there is not a sector that mentions your business, look at the sectors for ‘Businesses not mentioned elsewhere||There’s one for retail, one for business services and one for manufacturing.|
|5||If you still have not found a sector, you can use ‘Any other activity not listed elsewhere||Only use this sector if your business does not fit with anything else.|