How does the Flat Rate VAT Scheme work for small businesses?

The Flat Rate VAT Scheme is a simplified way for small businesses to calculate and pay VAT to HMRC. Instead of working out the exact VAT on every purchase and sale, you pay a fixed percentage of your gross (VAT-inclusive) turnover.

Who can join?

You can use the Flat Rate Scheme if your VAT taxable turnover (excluding VAT) is £150,000 or less per year. You must leave the scheme if your total business income exceeds £230,000 in any 12-month period.

How it works:

• You still charge VAT at 20% on your invoices to customers.
• You pay HMRC a flat percentage of your gross turnover. The percentage depends on your type of business.
• You keep the difference between what you charge customers and what you pay HMRC.

Example flat rate percentages:

A 1% discount is available in your first year of VAT registration.

Limited cost trader rules:

If your spending on goods is less than 2% of your turnover (or less than £1,000 per year), you are classified as a limited cost trader and must use a flat rate of 16.5%. This rule mainly affects service-based businesses with low material costs, and it significantly reduces the potential benefit of the scheme.

Advantages: Simpler record-keeping, less time on VAT administration, and potentially paying less VAT than under the standard method.

Disadvantages: You cannot reclaim VAT on most purchases (except capital assets over £2,000).