Although most UK businesses operate via the standard VAT scheme, some limited companies may be better off by using the flat rate VAT scheme, which came into force in 2002.
Flat Rate VAT – The basics
The flat rate scheme makes the calculation of VAT far simpler than the standard scheme. Although you charge clients and customers the standard 20% VAT rate on all invoices, you repay VAT on an annual basis of 14.5% if you are an IT contractor (or the relevant percentage according to your occupation or profession – see here for the HMRC table).
Whether or not you are financially better off by operating through the flat rate VAT scheme or not will depend on your own circumstances. If you buy a lot of equipment, for example, you may not benefit, as you cannot reclaim the VAT on purchases.
New rules from April 2017
In an effort to reduce the tax benefit of using the FRS for companies who have low annual expenses, from April 2017 businesses deemed to be ‘limited cost traders’ will no longer be able to use beneficial flat percentage rates. Instead, they will have to use a fixed 16.5% rate – meaning that any benefit of joining the FRS no longer exists.
This is likely to affect a large number of small limited companies. Find out more here.
Flat Rate VAT Scheme – Notes
- In your first year of registration, you receive an extra 1% reduction in the flat rate percentage you apply. In the case of most contractors, you will therefore repay 13.5% to HMRC.
- You can join the scheme if your annual taxable turnover (excluding VAT) will be £150,000 or less; and your annual total turnover (including VAT) will be £187,500 or less.
- If you outlay £2,000 or more on a single capital asset (including VAT) you can claim the input tax on your VAT return in the normal way.
- Although you pay back a lower percentage under the scheme, you should continue to invoice clients at the standard VAT rate (currently 20%).
- Your company can elect to leave the flat rate scheme at any time.
- You can continue in the flat rate scheme unless your turnover breaches the £230,000 mark.
Flat Rate VAT Scheme – Example
Here is an example for a limited company with gross client billings of £40,000, and VAT on expenses incurred of £500.
Standard VAT Calculation
Total Billings @ £40,000
Output VAT @ 20% = £8,000
(minus) Input VAT @ £500
Total VAT Payable would be £7,500
Flat Rate Scheme
Total Billings @ £40,000
Output VAT @ 20% = £8,000 (Added to total for purposes of calculating flat rate VAT)
Total VAT payable would be 14.5% of £48,000 = £6,960
This example uses the 14.5% percentage applied to IT contractors since 4th January 2011. Other professions and occupations may have different rates.
(Don’t forget that you have a 1% reduction in the percentage you pay to HMRC for the first year using the flat rate scheme).
In general, if you are unlikely to make many purchases through your limited company, you may well be better off by joining the flat rate VAT scheme.
Always check with your accountant before deciding which scheme to join.
For more information, consult HMRC’s guide to the flat rate VAT scheme, which includes all the flat rate percentages.