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What is the flat rate scheme for VAT?

12 November 2020
Mark Friend
Building & Construction, Reducing Tax, Accounting & Compliance

The flat rate scheme was first introduced in the 2002 budget and is a simple way for small businesses to account for VAT on their supplies.

Basically if your business is VAT registered and you use the flat rate scheme you still add VAT at 20% on your supply invoice. For example if you are a VAT registered plumber and you carry out a job for £100 plus VAT you will invoice £120.

Your invoices are therefore raised in exactly the same way as if you were on invoice or cash accounting.

The beauty however is in the reporting of your VAT liability. You would usually work out how much VAT you have charged and then deduct the VAT you incur on expenditure to calculate the liability that you must pay to HMRC. However for those on the flat rate scheme there are pre-set percentages which you can use to effectively calculate the VAT liability.

The percentages are set based on your industry type and the actual percentages can be determined here. During the period 15th July 2020 and 12th January 2021 the rates have been temporarily amended with the revised rates here.

For example if over a 3-month period a plumber did £20,000 + VAT in sales his total gross income would be £24,000. If you go to the HMRC site you will see that provided he spends 10% or more of turnover on materials then the percentage he can use is 9.5%. His VAT liability is 9.5% of £24,000 which equals £2,280.

Whether this is good or bad depends on the circumstances. For example if the plumber was working on new builds and his invoice was zero rated he would still need to pay 9.5% of his grow turnover which could result in the flat rate scheme being disadvantageous. However if he incurred a lot of VAT on materials there could be a big VAT saving.

The beauty of the scheme is simplicity and as part of our role as accountant we will review whether it is best for your business to be on cash or invoice accounting or whether to use the flat rate scheme. For many of our clients we carry out this exercise on a yearly basis to determine whether those not currently on the scheme should be and whether those that are on the scheme should come off. Annual checking is key as the savings for not being on the scheme or vice versa can run into the thousands of pounds!

The scheme is only available to VAT-registered business whose VAT taxable turnover is expected to be £150,000 or less (excluding VAT) in the next 12 months.

You cannot use the scheme if:

  • you left the scheme in the last 12 months
  • you committed a VAT offence in the last 12 months, for example VAT evasion
  • you joined (or were eligible to join) a VAT group in the last 24 months
  • you registered for VAT as a business division in the last 24 months
  • your business is closely associated with another business
  • you’ve joined a margin or capital goods VAT scheme

Once you have joined the scheme you must leave the scheme if:

  • you’re no longer eligible to be in it
  • on the anniversary of joining, your turnover in the last 12 months was more than £230,000 (including VAT) – or you expect it to be in the next 12 months
  • you expect your total income in the next 30 days alone to be more than £230,000 (including VAT)

There are a few quirks to the system.

If you are newly registered for VAT you get a further 1% discount for the first 12 months of being VAT registered.

As stated previously you can’t reclaim VAT on expenditure when you’re using the Flat Rate Scheme. However if you buy a capital asset that cost over £2,000 including VAT – you can reclaim the VAT on the asset, but must pay standard VAT on that asset when you sell it on. So you can recover the VAT when you buy an expensive computer, a van or plant and machinery provided the expenditure exceeds £2,000 and you have a VAT receipt. Please note however that not all capital assets qualify. If a  shopkeeper buys bricks, cement and fittings from their local builder’s merchant intending to employ a builder to convert them into an extension of the business premises – no VAT is reclaimable as bricks and so on are not capital expenditure goods.

Another major anomaly is if you only spend a small amount on goods.

If you do you could be classified 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%)

If you are a limited cost business you will need to pay a higher rate of 16.5% irrespective of your business type. Using the following link you can calculate if you need to pay the higher rate and work out which goods count as costs.

Should I join the flat rate scheme?

If you struggle with your book-keeping then for simplicity purposes the flat rate scheme is great.

If you are fine with the book-keeping then you need to consider what would be a typical VAT quarter for sales and purchases to work out if it is beneficial. There is no definitive answer. You have to look at this on a case by case basis as the saving could be significant.

Finally if you are in construction please be aware of the potential VAT changes which are going to impact the Construction industry from 1 March 2021. The implementation has been delayed and was supposed to take place on 1st October 2020. We outlined the changes in our blog entitled the next steps re VAT domestic charge for the construction industry. In the blog we highlighted the key changes which would lead to the flat rate scheme being pointless for most small businesses impacted by the changes and that most if not all should move to cash or invoice accounting for VAT.

If you are unclear about whether the flat rate scheme is right for you please contact us.

The content in this blog is correct as at 12/11/2020. See terms and conditions.

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