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If a business charges more VAT to customers than it pays on its own purchases, the difference must be paid to HMRC. Conversely, if a business pays more VAT than it charges, the difference can be reclaimed from HMRC. However, the VAT Flat Rate Scheme works differently – and this is what we will look at in this blog.
Value Added Tax (VAT) is charged by certain businesses on taxable supplies, such as the sales of goods and services.
VAT-registered businesses must account for VAT on the full value of what they sell, and they can also reclaim any VAT they have paid on business-related goods and services.
Figures for VAT charged and paid must be reported to HM Revenue and Customs (HMRC) through the VAT return, normally submitted every three months.
What is the VAT Flat Rate Scheme?
As we have already discussed, the amount of VAT a business pays or reclaims from HMRC generally consists of the difference between the amount of VAT charged by the business to its customers or clients and the amount of VAT it pays for its own purchases (i.e. from suppliers etc).
The VAT Flat Rate Scheme has different rules. Businesses which are registered on this scheme:
- pay a flat (fixed) rate of VAT to HMRC
- retain the difference between VAT charged to customers and the flat rate paid to HMRC
- Cannot reclaim VAT which they have paid (e.g. to suppliers) – unless they have certain capital assets in excess of £2,000
Which businesses can join the VAT Flat Rate Scheme?
Businesses with a VAT taxable turnover (i.e. the total of everything sold that is not VAT exempt) which exceeds £85,000, known as the ‘VAT threshold,’ are obliged to register for VAT. They can voluntarily register for VAT if they do not meet the VAT threshold.
There is a separate threshold figure for the VAT Flat Rate Scheme of £150,000, which works differently.
Businesses can opt to join the scheme as long as their taxable turnover does not exceed the £150,000 threshold. To join, they should expect their VAT taxable turnover to be £150,000 or less (excluding VAT) over the next 12 months. If taxable turnover increases since joining the Flat Rate Scheme, they may be required to leave the scheme.
Leaving the scheme
A business is obliged to leave the VAT Flat Rate Scheme if:
- They are no longer eligible to be in it (see below)
- On the anniversary of joining, their turnover in the last 12 months exceeded £230,000 (including VAT)
- They expect their turnover to exceed £230,000 (including VAT) in the next 12 months
- They expect their total income in the next 30 days alone to exceed £230,000 (including VAT)
Which businesses cannot join the VAT Flat Rate Scheme?
Businesses are not eligible to join the VAT Flat Rate Scheme if:
- They left the scheme within the previous 12 months
- They committed a VAT offence in the previous 12 months (e.g. VAT evasion)
- They joined (or were eligible to join) a VAT group in the previous 24 months
- They registered for VAT as a business division in the previous 24 months
- Their business is ‘closely associated’ with another business (for an explanation see VAT Notice 733)
- They have joined a margin or capital goods VAT scheme
Furthermore, businesses cannot use the VAT Flat Rate Scheme with the Cash Accounting Scheme.
Is the VAT Flat Rate Scheme entirely optional?
No business is required to join the VAT Flat Rate Scheme.
Although businesses which break the regular VAT threshold (£85,000) are legally required to register for VAT, they are under no obligation to even consider the Flat Rate Scheme.
Opting in and out of the VAT Flat Rate Scheme
Businesses can join the scheme online when they register for VAT. Alternatively, they can complete form VAT600FRS and email it to firstname.lastname@example.org (or send it by post to the address on the form).
If a business wants to join both the VAT Flat Rate Scheme and the Annual Accounting Scheme, they can apply using the form VAT600AA/FRS.
When a business wants to leave the scheme, or is required to do so, they must write to HMRC.
How does a business calculate its flat rate?
There is a different flat rate for each type of business (e.g. 11% for the advertising sector compared to 13% for hairdressing or beauty industry services). For a full list of rates according to business type, see GOV.UK.
There is a discount of 1% on these fixed rates for businesses which are in their first year as a VAT registered business.
Limited cost businesses
A business is classed as ‘limited cost business’ if it spends (i), less than 2% of their annual turnover on goods or (ii), less than £1,000 if its total spend on goods is more than 2%.
Limited cost businesses are required to pay a higher flat rate of 16.5%.
VAT inclusive turnover
The tax paid is calculated by multiplying the relevant flat rate percentage by the VAT inclusive turnover (i.e. the value of sales including VAT charged).
For example, a hairdresser who charges a total of £2,400 to her clients (i.e. £2,000 plus VAT at 20%) would multiply £2,400 by the flat rate which applies to hairdressers (13%). So the amount payable would be £312.
What are the pros and cons of the VAT Flat Rate Scheme?
- Completing a VAT Flat Rate Scheme return is normally more straightforward than filling in a standard rate VAT return.
- New businesses can benefit from the 1% discount in the first year of trading.
- Depending on their individual circumstances, it can save businesses money.
- VAT cannot be reclaimed on purchases.
- Exempt income (e.g. residential rent) is taxed on the flat rate.
- Identifying the correct VAT flat rate based on the business type can be challenging.