A Review of the VAT Flat Rate Scheme for Your Business

A Review of the VAT Flat Rate Scheme for Your Business

VAT or (Value-Added Tax) has always been more or less a nuisance for business owners. But recently, the VAT Flat Rate Scheme has also been changed in ways that don’t make it viable any longer for businesses. In 2017, the UK government introduced revisions in the VAT Flat Rate Scheme, which has existed since the 2002 Budget.

In this post, we will discuss some of these changes and their relevance to your business.

What is VAT?

Value-added tax (commonly VAT) is a tax levied on the sales of goods and services. VAT-registered businesses charge their customers a VAT rate of 20% on the goods or services they purchase. The taxable turnover threshold is currently £85,000 which determines whether a business must be registered for VAT.

What Is the Flat Rate Scheme?

According to the UK government, the Flat Rate Scheme has been designed to simplify your business’ record-keeping of sales and purchases. You pay a fixed flat rate percentage to your gross turnover in order to determine the VAT due. That fixed flat rate is determined depending on your business sector.

VAT Flat Rate Scheme Eligibility

The VAT Flat Rate Scheme is a simplified accounting scheme targeted at small businesses. It allows businesses to apply a fixed flat-rate percentage to their gross turnover to arrive at the VAT due. 

Eligibility for the scheme is determined by several factors.

  • Your business must be a VAT-registered business in the UK.
  • Your business’s annual taxable turnover, excluding VAT, must be £150,000 or less. 

It’s important to note that the turnover limit includes everything that you sell, which is liable for VAT. This includes standard, reduced rate, or zero rate sales or other supplies. It excludes VAT itself, sales of capital assets, and sales not done in the course of business.

If your business is eligible and chooses to use the Flat Rate Scheme, you still charge VAT to your customers at the rate applicable to your goods or services. But when you pay the VAT to HMRC, you pay at the flat rate applicable to your business sector.

However, the scheme may not be beneficial for all businesses. For instance, if you purchase a lot of goods and services, you might be better off with standard VAT accounting. This is because under the Flat Rate Scheme, you can’t reclaim the VAT on your purchases, except for certain capital assets over £2,000.

In conclusion, while the VAT Flat Rate Scheme simplifies record keeping, businesses should assess their eligibility and potential benefits carefully. It’s always advisable to consult with a tax professional when making such decisions.

VAT Flat Rate Scheme Threshold Explained

The VAT Flat Rate Scheme threshold is determined by the VAT-inclusive turnover of the business. If the VAT-inclusive turnover of the business in the next year will be £150,000 or less, the business can join the scheme. Once in the scheme, the business can stay in until its VAT-inclusive turnover over the last 12 months was more than £230,000.

It’s important to note that the VAT Flat Rate Scheme isn’t beneficial for all businesses. For instance, businesses that incur a significant amount of VAT on expenses, or those that operate on low-profit margins, may find the scheme less beneficial. Therefore, it’s crucial for businesses to assess their individual circumstances and consult with a tax professional before deciding to join the scheme.

Advantages and Disadvantages of the VAT Flat Rate Scheme

Advantages

Simplified Accounting

The VAT Flat Rate Scheme was introduced by HM Revenue and Customs in the 2002 Budget to alleviate the administrative stress of preparing VAT returns for small businesses and small limited companies.

Increased Profit Margins (Pre-2017)

Until 2017, the scheme allowed small businesses to increase their profit margins. The flat rate of VAT paid on their sales was significantly lower than the headline VAT rate charged to their customers, allowing businesses to keep the difference.

Disadvantages

Higher Flat Rate for Limited Cost Traders (Post-2017)

From 1st April 2017, the UK government introduced a higher flat rate of 16.5% for “limited cost” traders. This is defined as businesses whose VAT-inclusive expenditure on goods is either below 2% of their VAT-inclusive turnover in a prescribed period, or above 2% of their VAT-inclusive turnover but less than £1,000 per annum.

No Reclaiming of VAT on Purchases

Unlike Standard VAT Accounting, businesses cannot reclaim VAT on their purchases under the Flat Rate Scheme. This can be disadvantageous for businesses with a high amount of VAT-able expenses or those that buy stock.

Taxation of Exempt Income

If a business is registered for the scheme, its “exempt” income, such as income earned from leasing out commercial land or property, is taxed at the flat rate. This also applies to zero-rated and reduced-rate supplies, which can be a major trap for businesses. The only exception is bank account interest.

Why Are Flat Rate Schemes No Longer Beneficial? 

A key challenge that businesses face is that it is difficult to identify the correct VAT flat rate based on their business type. It’s often unclear what trade class a business belongs to. Moreover, HMRC refuses to make a decision on the scheme’s rate on behalf of the business and can even challenge the rate chosen by the business.

Your business’ growth rate is another important factor in determining the usefulness of the Flat Rate Scheme. If your business’ revenue is likely to quickly exceed the upper threshold of £230,000, you will have to leave the Flat Rate Scheme soon anyway. 

So, it is essential that you consider your business plan and forecast turnover figures to see if there is an expectation of quick growth. If there is, then it’s more beneficial to register under the standard scheme from the start to create a good practice.

VAT Flat Rate Scheme vs. Standard VAT Accounting

It has become increasingly nonviable for your business to register for the VAT Flat Rate Scheme. Instead, choosing the Standard VAT Accounting Scheme and streamlining your accounting work is a much better option in the long run. This will ensure that you can reclaim VAT on your purchases and will allow you to have a better command over your books without unnecessary administrative stress.

Every business is different and has different sets of needs according to its VAT-able purchases and expenses. Therefore, it’s good to speak to your accountant to decide which scheme is more suitable and beneficial for your business, both from an administrative and taxation perspective.

How Q Accountants Can Help with VAT Flat Rate Scheme

Understanding the VAT Flat Rate Scheme can be complex, but you don’t have to do it alone. At Q Accountants, our team of experts will provide expert guidance tailored to your business needs, whether you’re considering the scheme for the first time or need help navigating recent changes.

Don’t let VAT administration stress you out. Contact us today and let us help you make the most of the VAT Flat Rate Scheme.

Your business deserves the best, and we’re committed to providing it. Book a discovery call with us today!

Frequently Asked Questions

  1. How does VAT flat rate scheme work?

    The VAT flat rate scheme is a simplified method for small businesses to calculate their VAT liability. Under this scheme, instead of calculating and reclaiming the VAT on each individual sale and purchase, a flat rate percentage is applied to turnover (excluding VAT) to determine the VAT liability. This flat rate percentage varies depending on the industry in which the business operates. The scheme aims to simplify the VAT process and reduce administrative burden for small businesses. 

    However, it is important to note that businesses using this scheme cannot reclaim VAT on purchases, except for capital assets over £2,000 (including VAT). Overall, the VAT flat rate scheme provides a streamlined approach to VAT accounting for eligible businesses.

  2. How is flat rate scheme calculated?

    The flat rate scheme is calculated by applying a predetermined percentage to your total taxable turnover. This percentage is determined based on your business sector, and it takes into account the amount of VAT you would usually be required to pay on your sales. 

    With the flat rate scheme, you pay a fixed rate of VAT on your total sales, regardless of the amount of VAT you charge your customers. This simplifies the VAT process for small businesses by removing the need to calculate and keep track of input and output VAT.

  3. When did VAT flat rate scheme change?

    The VAT Flat Rate Scheme changes were confirmed by HMRC and became effective from 1 June 2022. There were also changes to the scheme that started on 1 April 2017.

  4. What is the turnover limit for UK flat rate VAT?

    To join the Flat Rate Scheme, your VAT turnover must be £150,000 or less (excluding VAT), and you must apply to HMRC.

  5. Can you backdate flat rate VAT?

    Yes, it is possible to backdate UK Flat Rate VAT in certain circumstances. HMRC allows businesses to retrospectively join the Flat Rate Scheme, but only in 'exceptional' circumstances. 

    Most often, a business that has not registered for VAT at the correct time and has its VAT registration backdated by HMRC will be allowed to join the Flat Rate Scheme with effect from the date of registration.

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