The flat-rate VAT scheme is a simplified VAT accounting method designed to reduce the administrative burden for small businesses. While it offers benefits like streamlined reporting, it’s not suitable for everyone. In this article, we’ll outline how the scheme works, its pros and cons, and help you decide if it’s the right fit for your business.
What is the flat-rate VAT scheme?
The flat-rate VAT scheme allows businesses to pay a fixed percentage of their VAT-inclusive turnover to HMRC, instead of calculating VAT on individual transactions. This percentage varies depending on your business sector and reflects average VAT liabilities for similar businesses.
It’s important to note that under this scheme, you can’t reclaim VAT on most purchases, except for capital assets worth £2,000 or more (including VAT). This makes the scheme best suited to businesses with minimal VATable expenses.
Who can use the flat-rate VAT scheme?
To join the flat-rate VAT scheme in the 2024/25 tax year, your business must:
- be VAT-registered
- have an expected VAT-inclusive turnover of £150,000 or less in the next 12 months.
You must leave the scheme if your turnover exceeds £230,000 (VAT-inclusive), or if you no longer meet the eligibility criteria.
How does it work in practice?
Once you’ve determined your flat-rate percentage, applying it is straightforward. For example, if your business falls under the category of retail other than food, confectionery, tobacco or newspapers with a flat rate of 7.5%, and your VAT-inclusive turnover is £100,000, your VAT liability would be:
£100,000 x 7.5% = £7,500.
Compare this to standard VAT accounting, where you’d calculate VAT on individual sales and offset it against the VAT on purchases. While this method might be more precise, it also involves significantly more paperwork.
What are the benefits?
- Simplified record-keeping: You don’t need to track VAT on every sale and purchase, which saves time and reduces the likelihood of errors.
- Predictable payments: With a fixed percentage, it’s easier to budget for VAT payments.
- First-year discount: New VAT-registered businesses can reduce their flat rate by 1% during their first year in the scheme.
What are the drawbacks?
- Limited input VAT recovery: If your business has high VATable expenses, the inability to reclaim VAT could outweigh the benefits of simplified accounting.
- Potential higher payments: Depending on your flat-rate percentage and turnover, you might end up paying more VAT under this scheme than with standard VAT accounting.
- Sector classifications: Choosing the correct percentage for your business type is essential. Misclassification can lead to underpayments or penalties.
Who benefits most from the flat-rate VAT scheme?
The scheme works best for service-based businesses with low VATable expenses, such as consultants, freelancers or small retail shops. For businesses with significant expenditure on goods, especially those buying from VAT-registered suppliers, the standard VAT scheme is usually more beneficial.
How to apply for the flat-rate VAT scheme
If you decide the flat-rate VAT scheme is right for your business, you can apply by completing form VAT600 FRS or by using your VAT online account. Once accepted, you’ll start using the scheme from the start of your next VAT accounting period.
Should you switch to the flat-rate VAT scheme?
The decision to join the flat-rate VAT scheme isn’t one to take lightly. While it can simplify your VAT reporting and reduce administrative work, it’s not a one-size-fits-all solution. Businesses with minimal VATable expenses and straightforward operations often benefit most from the scheme, especially if cashflow and time savings are priorities. However, for those with significant VATable purchases or more complex financial needs, the standard VAT accounting method may still be the better option.
Choosing the right VAT scheme is a key financial decision that can have a direct impact on your business’s profitability. If you’re unsure about which option is best for your situation, we’re here to help. At Thomas Barrie, we work closely with businesses to provide tailored advice, ensuring you’re not only compliant but also maximising your financial efficiency.
Here are a few questions to consider.
- Do you have low VATable expenses relative to your turnover?
- Does your business fall into a category with a low flat-rate percentage?
- Would you benefit from simplified VAT accounting and reduced administrative time?
Contact us today to speak to one of our VAT experts, and let’s find the solution that works best for you.