Flat Rate VAT: What you Need to Know

Flat Rate VAT: What you Need to Know

In the middle of a rather confusing landscape surrounding the VAT changes and the impact it could have on the Flat Rate Scheme, it is best to navigate through the potential traps, possible savings, and, of course, benefits. Although it appears to be attractively simple at first, the Flat Rate Scheme has a number of pitfalls waiting for small business owners to fall into.


What is Flat Rate Scheme?

Introduced in 2002, the Flat Rate Scheme (FRS) is available to sole proprietorships or small businesses and has little to do with standard VAT accounting. In FRS, you don’t pay VAT on the difference between purchases and sales rather than a percentage of turnover. The FRS rate varies among sectors (i.e. for IT contractors, it Is 14.5%).


In brief, this is how it works: (1) prepare invoices adding VAT at 20% (the normal procedure), and (2) apply the relevant flat rate to the gross invoice amount (the VAT-inclusive total). The latter signifies the amount of VAT you have to pay to HMRC.


For example*:


Invoices £2,000
VAT £400
Turnover (VAT Inclusive) £1,200
Flat Rate VAT (here, 10%) £240
Business Income £2,160


*Unless for capital expenditure that exceeds £2,000 (VAT included), expenses are ignored.

Even though it appears that the business in the example has magically increased its income, let’s not forget that no input VAT is being reclaimed on expenses.

The flat rate per industry is defined by the HMRC, with several different percentage rates per trade. Your specific circumstances will show whether the rate for your small business will be advantageous or not. For instance, assume two companies have a part-time employee; one uses the assistant on a self-employed basis while the other employs the assistant. If the assistant is registered for VAT, the second company will have no VAT cost (on the part-time assistant) whereas the first company will suffer VAT but won’t be able to reclaim this.

Important Notes:

The Flat Rate Scheme has some complications that could catch out those unsuspected.

  1. The flat rate only applies to zero-rated, as well as reduced and standard rate turnover. It also applies to except income (i.e. residential lettings). In other words, if you are a trader with a buy-to-let property and decide to move to the FRS, you instantly become liable for VAT on the income you get from renting the property.
  2. Purchasing and selling products or services outside the UK (to the EU and the rest of the world) cause further complications on applying VAT. Generally speaking, any work done for EU businesses is excluded from the FRS calculation; hence, is outside the cope of UK VAT.
  3. The Flat Rate Scheme was introduced with small businesses’ best interest in mind (to reduce their costs and administration time). Regardless if the scheme has met its objectives or not, it benefits HMRC since they can check VAT liabilities much easier than before, without having to go through dozens, if not hundreds, of expense receipts.
  4. To be able to know if the FRS is indeed beneficial to you, the small business owner, you will have to compare the outcome from using the normal rules with the outcome from the FRS. So, calculate VAT in both using the flat rate and the normal way. This should give you a straightforward answer in purely financial terms.
  5. The only case where you can reclaim for VAT on expenses within the FRS is on capital expenditure over £2,000 (VAT inclusive).

6.For newly-found organisations that are registered, the flat rate is reduced by 1% for the first 12 months of registration (not the FRS). This means that it will apply in full if you decide to enter the FRS on registration.


Why opt for the FRS?

Simply put, it makes record keeping and VAT calculations simplified, which is particularly helpful if you are running a small business and may not have the expertise or time to conduct your accounting in the standard (traditional) way. Not to mention the penalties that are charged for accounting errors. In short, it removes the obligation to keep a record of VAT paid on purchases or charged for each sale individually (therefore, it shortens the process). Nevertheless, you still have to show a VAT amount on every invoice.

To keep up-to-date with VAT issues or for further advice, feel free to contact us. Always available to provide you with the best accounting and consulting services to meet your needs.

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