How the Flat Rate Scheme works
Under standard VAT accounting you pay HMRC the VAT you charge customers, less the VAT you pay on your own purchases. The Flat Rate Scheme replaces that with a single sum: you still charge customers VAT at the normal rate, but you pay HMRC a fixed percentage of your VAT-inclusive turnover and keep the difference. In exchange you cannot reclaim VAT on purchases, except on a single purchase of capital goods costing £2,000 or more including VAT.
HMRC's own example: a photographer bills a customer £1,000 plus 20% VAT, £1,200 in total. The flat rate for photography is 11%, so the business pays HMRC £132 and keeps £68 of the £200 VAT it charged.
Who can use it
- Joining. You must be VAT registered and expect taxable turnover of £150,000 or less, excluding VAT, in the next 12 months;
- Leaving. You must leave if, on the anniversary of joining, turnover including VAT in the last 12 months was more than £230,000 or you expect it to be in the next 12 months, or you expect more than £230,000 in the next 30 days alone;
- Exclusions. You cannot join if you left in the last 12 months, are closely associated with another business, use a margin or capital goods scheme, or have recently been in a VAT group;
- Cash accounting. The two schemes cannot be combined, but the Flat Rate Scheme has its own cash-based turnover option.
Flat rate percentages
Your percentage depends on the trade sector your business earns most of its turnover from. A selection of HMRC's rates:
| Business type | Flat rate |
|---|---|
| Accountancy or book-keeping; computer and IT consultancy; lawyer or legal services; architect or surveyor; labour-only building | 14.5% |
| Management consultancy; real estate activity not listed elsewhere | 14% |
| Catering services including restaurants and takeaways; entertainment or journalism | 12.5% |
| Any other activity not listed elsewhere; business services not listed elsewhere | 12% |
| Advertising; photography; publishing; social work | 11% |
| Hotel or accommodation | 10.5% |
| General building or construction services | 9.5% |
| Retailing not listed elsewhere | 7.5% |
| Pubs | 6.5% |
| Retailing food, confectionery, tobacco, newspapers or children's clothing | 4% |
| Limited cost business (any sector) | 16.5% |
The calculator includes all 54 sectors in HMRC's table.
The limited cost business test
Since April 2017 businesses that buy very few goods pay 16.5% whatever their sector. You are a limited cost business if what you spend on relevant goods, including VAT, is either less than 2% of your VAT-inclusive turnover, or more than 2% but less than £1,000 a year (£250 a quarter). Relevant goods are goods used only for the business. They exclude services (including rent, downloaded software and fees), capital expenditure goods of any value such as laptops and phones, food and drink for you or your staff, vehicle costs including fuel (unless you are in the transport sector), promotional items and gifts, and goods for resale or hire unless that is your main business. Stock for a shop and gas and electricity used only for the business do count.
At 16.5% of VAT-inclusive turnover you pay HMRC 19.8% of your net sales, so you keep just 0.2% of the 20% VAT you charge while losing the right to reclaim VAT on costs. Most consultants and contractors with few purchases are better off on standard accounting. The test applies to each VAT return, so you can move between the sector rate and 16.5% from quarter to quarter.
The first-year discount
In your first year of VAT registration you take 1% off your flat rate, for example 13.5% instead of 14.5%. The discount runs until the day before the first anniversary of your VAT registration, not of joining the scheme, so joining late in the first year shortens it. It is not available if you registered more than 12 months after you were required to.
Worked example
An IT consultant with annual sales of £80,000 plus VAT spends £600 a year on relevant goods and pays £1,500 of VAT on all her purchases.
- VAT-inclusive turnover. £80,000 + £16,000 VAT = £96,000;
- Limited cost test. £600 is below 2% of £96,000 (£1,920), so she is a limited cost business;
- Flat rate VAT. 16.5% × £96,000 = £15,840;
- Standard VAT. £16,000 − £1,500 = £14,500;
- Result. Standard accounting saves her £1,340 a year.
If she bought £2,500 of relevant goods instead, she would pass the test and use the 14.5% sector rate: flat rate VAT of £13,920, which is £580 less than standard accounting on the same input VAT. More purchases would also raise her reclaimable input VAT, though, so enter both figures to compare.
What this calculator does not cover
- Mixed rates. It assumes all sales are at one VAT rate; enter your main rate or run it twice;
- Exempt and non-business income. Exempt income counts in flat rate turnover but not in standard VAT;
- Capital items. VAT on single purchases of £2,000 or more is reclaimable under both methods, so leave it out;
- Part-year returns. The limited cost test is applied to a full year, not to each quarter;
- Stock on joining or leaving. Adjustments for stock and assets when you join or leave the scheme are not included.
Getting it right
The scheme saves time, but the right choice depends on your costs, your customers and how your business is likely to grow. Our VAT planning team can model the options, and our VAT returns service handles the quarterly limited cost test for you. For your income tax position as a sole trader, try the self-employed tax calculator.