Are contractors better off using the Flat Rate VAT scheme?

Please note that a significant change was made the Flat Rate VAT scheme on 1st April 2017. If your company meets the HMRC definition of a ‘limited company trader’, you will have to pay a fixed rate percentage of 16.5% – a large tax increase on the previous fixed rate. Find out if you are affected here.

This question was answered before the April 2017 change took place, by specialist contractor accountants, Freestyle Accounting.

“This depends on the individual circumstances of the contractor and the manner in which they carry on their business.

“If the contractor incurs a large amount of expenses then they may be better off on standard VAT where they can recoup the entire input VAT they incur.

“In addition, if the contractor operates as a sole trader and has another business or a buy to let portfolio, then registering for the flat rate scheme as a contractor would result in them having to include the income from that other business in their VAT calculations, resulting in additional VAT being due.

“However, in our experience, the typical contractor, trading through a limited company and with a small amount of expenses will generally be better off electing for the flat rate scheme, especially as expenses such as travel, postage and some subsistence do not include VAT.

“We would, however, urge any contractor to take professional advice before registering as there are pitfalls which they may be unaware of.”

How does the Flat Rate VAT scheme work?

Under the Flat Rate scheme, rather than accounting for each VAT-able transaction (both purchases and sales), you pay a fixed percentage rate of your turnover to HMRC. At the time of writing, the fixed rate for IT contractors is 14.5% (July 2016).

You don’t claim back the VAT on purchases, as this has already been factored into the flat rate percentage according to the industry type, although you should be able to claim back the VAT on certain capital purchases made by your company if the total VAT-inclusive price is £2,000 or more.

As an extra incentive, businesses that join the scheme are eligible for a further 1% reduction of their fixed rate percentage for the first year.

The aim of the scheme is to make VAT accounting simpler for smaller businesses. You can join if you expect your turnover to be £150,000 or less over the next 12 months, and can remain within the scheme unless your turnover becomes greater than £230,000.

Further information

You can read more in our guides to the Flat rate VAT scheme, and the standard VAT scheme.

The official HMRC guide to the Flat Rate Scheme can be read here.

Last updated: 16th June 2019