The VAT Flat Rate Scheme lets eligible small businesses calculate VAT payable by applying a sector percentage to VAT-inclusive turnover. The business still charges customers the normal VAT rate but usually does not reclaim VAT on individual purchases, except for qualifying capital assets costing at least £2,000 including VAT.
Who can join?
A VAT-registered business can normally apply where expected VAT-taxable turnover, excluding VAT, is £150,000 or less in the next 12 months. HMRC can refuse or remove a business where scheme rules are abused or eligibility conditions are not met.
When must a business leave?
Leave if, on the anniversary review, total business income exceeds £230,000 including VAT, or is expected to exceed that amount in the next 30 days alone. Other exit events include joining a VAT group or becoming associated with another business under the rules.
How the calculation works
Apply the relevant flat-rate percentage to VAT-inclusive scheme turnover:
VAT-inclusive turnover × flat-rate percentage = VAT payable.
Percentages vary by trade. The difference between VAT charged to customers and the scheme payment contributes toward irrecoverable input VAT and is reflected in business profit for direct-tax accounts.
Worked example
A consultancy invoices £10,000 plus £2,000 VAT. VAT-inclusive turnover is £12,000. If its applicable percentage is 14.5%, the scheme payment is £1,740. The £260 difference from output VAT is not automatically pure saving because most purchase VAT cannot be reclaimed.
First-year discount
A newly VAT-registered business can generally reduce its sector percentage by 1 percentage point until the day before the first anniversary of VAT registration. It is not available merely because an existing VAT-registered business joins the scheme later.
Limited cost trader rule
A limited cost business uses 16.5% if relevant goods are less than both:
- 2% of VAT-inclusive turnover; and
- £1,000 a year, adjusted for a shorter period, where the 2% test is exceeded.
Relevant goods exclude capital expenditure, food and drink for the business, vehicles and fuel in many circumstances, and services such as software, accountancy, rent and advertising. Test each VAT period.
At 16.5%, a business keeps only £1 of each £120 standard-rated invoice before considering irrecoverable input VAT, so the scheme can be unattractive.
Which percentage applies?
Choose the category that best describes the main business activity by turnover. Similar labels can have different percentages. If activities change, review the classification. Retain evidence supporting the choice; a SIC code does not automatically determine the VAT sector.
Input VAT claims
Most input VAT cannot be reclaimed separately. Exceptions include:
- qualifying single purchases of capital goods costing £2,000 or more including VAT;
- certain pre-registration input tax under normal rules;
- specific transactions outside the scheme calculation.
The capital-goods exception does not normally cover services, leased assets or multiple separate items bundled merely to exceed £2,000.
What turnover is included?
Scheme turnover generally includes standard-, reduced- and zero-rated supplies and some other income. Exempt supplies are normally excluded from the flat-rate turnover calculation under the detailed rules, while sales of certain capital assets follow special treatment. Grants, deposits and reverse charges need review.
Cash-based method
Flat Rate businesses can often choose a cash-based turnover method, accounting when payment is received. This is distinct from the main VAT Cash Accounting Scheme. Apply one coherent method and document transitions.
Advantages
- simpler VAT calculations;
- less purchase-VAT analysis;
- potential cash benefit for businesses with low costs;
- 1% first-year discount for newly registered businesses.
Disadvantages
- restricted input-tax recovery;
- 16.5% limited cost rule;
- possible losses for zero-rated or high-cost businesses;
- sector-classification risk;
- turnover and exit tests still require monitoring.
Records and MTD
Keep digital sales records, VAT-inclusive turnover, sector and limited-cost calculations, capital-asset invoices and joining or leaving dates. MTD for VAT still applies. Reconcile the scheme return to accounts and bank receipts.
Before joining
- Forecast normal output VAT and recoverable input VAT.
- Compare every relevant sector percentage.
- Test limited-cost status by quarter.
- Consider zero-rated, exempt and overseas income.
- Model capital expenditure and first-year discount.
- Review annually and before turnover spikes.
Official guidance
This guide is general information. Model the scheme using actual sales and costs before applying.
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