Flat rate VAT – is it right for my business?

The Flat Rate VAT scheme is a simplified version of the standard VAT scheme. It was introduced in 2002 and allows you to use a single rate of VAT throughout your business. The flat rate would only be used for calculating VAT due to HMRC. You will continue to invoice customers as normal and apply the rate of VAT you would ordinarily use (Standard VAT 20%, Reduced Rate 5%, Zero Rate 0%, etc). This means that you won’t have to worry about calculating your VAT using different rates for different goods or services, as you would if you were using the standard VAT scheme. However you will still need to keep VAT records.

While the Flat Rate Scheme can also be used with the Annual Accounting Scheme, it cannot be used with the Cash Accounting Scheme.

Whatever legal form your business takes (Limited Company, Partnership, Limited Liability Partnership or a Sole Trader), you are responsible for monitoring your turnover so you recognise when you must VAT registered. The current threshold for registering for VAT is £85,000 of annual turnover (although voluntary registration may be made before this threshold is breached).

How Does It Work?

To calculate your VAT payment under the scheme, multiply your gross turnover (including VAT), by your flat rate percentage. The flat rate percentage varies depending on your industry or business type, ranging from 4% to 14.5%* [1].

A first year discount can be applied if you are in your first year of VAT registration. You could be entitled to a 1% reduction in your flat rate percentage until the first anniversary of your VAT registration. Unfortunately you will not be entitled to apply the 1% reduction if you register for VAT 12 months after you were required to do so.

Example

You are a business providing secretarial services. You bill a customer for £1,000 (adding VAT of 20% – £200) to make it £1,200 total.

The flat rate for your secretarial services business is 13%

Your flat rate payment will be 13% of £1,200, which is £156.**

**The profit made in using the VAT Flat Rate Scheme increases your business profit.

In principle, this is taxable for the purposes of direct tax.

There is no obligation to keep a separate account of the “VAT Profit” as a result from use of the scheme; it will add to your profits that you would regularly report to HMRC.

HMRC has confirmed that for direct tax purposes, there is no additional analysis required and the standard of records is the same for both taxes. The accounts will look similar of those of a non-VAT registered business as the income will be gross revenue minus the Flat Rate VAT percentage and your expenses will include the irrecoverable input VAT.

*Limited Cost Business

If you spend a small amount on goods you will be classed as a “limited cost business”.

If your goods cost less than either:

• 2% of your turnover
• £1,000 a year (if your costs are more than 2%)

Then this will mean you be classified as a limited cost business and you will pay the higher rate of 16.5% for flat rate. This was introduced to clamp down on what the government felt were people manipulating the scheme. These businesses spend little on goods, so had very little equivalent input VAT.

If you are still unsure then you can use this tool to see if you meet the limited cost trader criteria.

Flat rate VAT advantages

There are many benefits to using flat rate VAT.

It’s reliable, predictable, and easy to administer.

QuickBooks notes that one of the pros of flat rate billing is that it makes time-tracking easy for contractors. With hourly billing, you have to meticulously track your hours to accurately bill the client, but with flat rate billing, the number of hours you work doesn’t matter, so you don’t have to track time for the client. [3]

Flat rate VAT can also be beneficial for small businesses who don’t have much experience handling finances or managing large amounts of paperwork. This means less chances of mistakes. If you’re just starting out, flat rate VAT may be right for you!

Flat rate VAT disadvantages

Flat Rate VAT only applies to businesses that have a VAT turnover of £150,000 or less (this excludes most SME’s). In addition, if your business experiences growth over time (which we hope it will!), then you’ll need to switch over from the flat rate scheme at some point before reaching the £150k limit—but this is something that many businesses are able to do without too much difficulty.

Some businesses may not benefit from the scheme if their expenses exceed the flat rate percentage for their industry, as they will end up paying more VAT than if they were under standard VAT accounting. For example – if you sell goods and services which are predominantly zero-rated or exempt, then it is possible you’ll end up paying more VAT. Business that usually claim input tax may not benefit from the Flat Rate Scheme. Similarly, added intricacies may occur for businesses who trade goods from outside the UK.  

According to FreshBooks, another con of flat rate billing is that if you are a newbie, it may be difficult to estimate the project rate accurately. This can lead to a huge risk of losing money on a project if the scope changes. Additionally, certain clients insist on hourly invoicing, and flat rate work can open you up to negotiating and haggling with clients over prices.[2]

With the Flat Rate Scheme, you can’t claim back any of the VAT you paid on purchases, unless you buy a capital asset that cost £2,000 (inc. VAT) or more. E.g. a computer.

Providing all capital purchases are on the same receipt (e.g. the computer, monitor & printer), you can claim the VAT back on these items. However if they are all bought separately and no single purchase equates to the £2,000 gross amount, then you will not be able to claim. They must all be made on the same purchase receipt.

If you are unsure what the requirement for something to be a capital asset, there is a full list available from HMRC.

If your business fits into more than one category because you make different kinds of sales, you’d choose the percentage that applies to the majority of your sales and apply that to your total sales.

Overall, whether the flat rate VAT scheme is right for your business depends on your specific situation. If you would like to discuss your options with us, please don’t hesitate to get in contact.

Sources:

1. https://www.gov.uk/vat-flat-rate-scheme/how-much-you-pay
2. https://www.freshbooks.com/hub/invoicing/flat-rate-vs-hourly         
3. https://quickbooks.intuit.com/r/payments/flat-rate-vs-hourly-billing/
4. https://www.gov.uk/guidance/flat-rate-scheme-for-small-businesses-vat-notice-733–2#reclaim-of-vat-on-capital-expenditure-goods

Don’t forget you can contact us here if you want to discuss flat rate VAT or any other business matters

This article was written by Amy