VAT Flat Scheme Explained (Basics)!

Kirsty Young Business Tips, Limited Company, VAT

If you are VAT registered and looking for either:

  • An easier life with your VAT obligations

AND/OR

  • A potentially cheaper way to deal with VAT

This article is for you!

 

How does VAT work?

When you are VAT registered, by default your business usually:

  • Collects VAT on the money you receive from customers/clients
  • Deducts VAT it has paid on costs
  • Hands over the rest to HM Revenue & Customs via a VAT return

You need to generally keep a detailed digital record of each transaction to work this out. This can be pretty time consuming and there are lots of opportunities for costly errors, especially if you don’t like book-keeping, or constantly researching what you can/can’t claim VAT back on,

 

The VAT Flat Rate Scheme

If you use the Flat Rate Scheme, all you do is:

  • Add up the money you’ve had in from your customers/clients
  • Apply a fixed percentage
  • Hand that over to HM Revenue & Customs with your VAT return

You don’t do the ‘reclaim/deduct your expenses’ part.

The Flat Rate Scheme’s fixed percentages are set to take into account what HMRC believe is a good amount for VAT that you might have reclaimed from your expenses.

So, you are effectively charging 20% (in general) on your sales, but only handing over (for example) 12% of the total cash received from the customer.

 

Why is the Flat Rate Scheme good for my business?

There are a few positives to the scheme:

  • As you only need apply a flat rate percentage to the money your business receives from its sales, there is far less book-keeping required
  • The flat rate percentage is effectively a guess from HMRC. Sometimes you win on the actual mount you are handing over, compared with what you would hand over if you worked it out in full
  • Generally, you won’t reclaim VAT on your expenses (as it’s built into the flat rate percentage). The good news is that you still can reclaim VAT on ‘big ticket items’ over £2000, like a new MacBook for example

 

Can anyone join the Flat Rate Scheme?

No, you generally need to:

  • Be VAT registered (obviously)
  • Expect your turnover to be under £150,000 in the next 12 months

There are other conditions, but these are the two big ones. More detail at HMRC site here.

 

This sounds great – what’s the catch?

The main one is being a ‘Limited Cost Business’. You will count as a limited cost business if the goods your business buys are less than either:

  • 2% of your turnover

OR

  • £1000 a year (if your costs are more than 2%)

If you don’t buy goods, parts, etc to resell (if you’re a service-based business for example), it can be hard to meet these tests.

If you do count as a limited cost business, you have to apply a 16.5% rate, rather than any lower percentage for your industry type.

 

20% vs 16.5% still sounds great to me…

Sadly, it’s not simply 20% vs 16.5%. Take this example.

You are selling a £1000 service.

NORMAL VAT RATE

£1000 + VAT(20%) = £1200

(The VAT is applied to your price at 20%).

You can divide your total price by 6 to get the VAT inclusive 20% part, in this case, £200.

 

FLAT SCHEME RATE

The flat rate scheme percentage is applied to all the money you receive, the full £1200, not the £1000.

Therefore £1200 16.5% = £198

That’s £200 on the standard scheme, £198 on Flat Rate.

 

BUT here’s the kicker. By paying 20% VAT, you can ALSO deduct any VAT you’ve paid out from the £200 before you hand it over. You can’t do this on the Flat Rate Scheme £198.

Therefore, if you’ve spent more than £2 of VAT on your business expenses, it’s likely you are better off on the standard scheme!

 

VAT Flat Rate Scheme List of Percentages

The list of percentages per type of business can be found here on HM Revenue & Customs site.

 

Vexed by VAT?

We feel your pain! If you don’t have an accountant, or feel you aren’t making the most of VAT options with your current accountant, we’d love a chat about how we can help.