HMRC Flat Rate VAT Scheme vs Standard Scheme

We outline what the HMRC flat rate VAT scheme is, how it compares to the standard scheme and which scheme is best for you.

We also provide a free VAT flat rate scheme calculator which allows you to work out which scheme is most profitable for you.

VAT registration threshold

We have detailed the current VAT registration threshold in our article here but you can consider voluntarily registering if it is to your benefit.

What is the standard VAT scheme?

Under the standard VAT scheme, you will typically do a quarterly VAT return where you report your VAT on your sales and VAT on your costs and you will pay HMRC the difference between the two (or get a refund if your VAT on costs is more than your VAT on sales).

So for example, if in a VAT quarter your sales are £20,000 + VAT and you have £750 of VAT on your costs to claim back, your VAT calculation would look like this:

VAT on Sales £4,000 (£20,000 x 20%)

less VAT on Costs £750

VAT due to HMRC £3,250

This is assuming you have a simple business where your sales are all standard rated UK sales.

What is the flat rate scheme?

The HMRC VAT flat rate scheme was brought in by HMRC to simplify VAT returns but it can also offer the possibility of making additional profit.

You still charge your clients standard rated VAT on your invoices, so they don’t see anything different. However when it comes to your VAT returns and paying HMRC what happens is this:

You take your total sales including VAT, in our earlier example this would be £24,000 (£20,000 + £4,000 VAT).

You then apply a flat rate percentage to this total inc VAT (gross) turnover.

We’ll discuss the percentages more shortly but for now let’s assume 12%.

12% multiplied by your total inc VAT sales of £24,000 = £2,880

The amount you pay HMRC is this £2,880, which is £1,120 less than the £4,000 of VAT your clients have paid you.

Sounds too good to be true? Well the trade-off is that you’re not allowed to claim back VAT on your costs so you have to run some calculations to see if the flat rate scheme benefits you or not.

So let’s compare the two schemes with our example figures:

VAT Flat Rate Scheme vs Standard Scheme

As you can see from the above in our example you would make a gain on the flat rate scheme of £370 for that quarters VAT return.

This is worked out like this:

  • Under the standard scheme you would pay HMRC VAT of £3,250 (£4,000 of VAT on sales less £750 of VAT on costs).
  • But under the flat rate scheme you only pay HMRC £2,880 , so even though you can’t claim VAT back on your costs you are still £370 better off.

This gain of £370 is additional profit to your business so will be taxable.

Which Flat Rate Category to use

One of the key deciding factors as to whether the flat rate scheme is best for you or not is going to be which flat rate category is the best fit for your business.

UPDATE – IMPORTANT:

On 23rd November 2016 HMRC announced changes to the flat rate scheme from April 2017 with regards to a new flat rate scheme category, the ‘limited cost trader’ – we have written an article below which should be read in conjunction with this article:

VAT Flat Rate Scheme Changes 2017 – Limited Cost Traders

Now carry on reading our original article below….

 

You can find a list of the HMRC business categories and the relevant percentages HERE but we have also listed them out below (HMRC change these now and then so always check for the most up to date percentages):

Type of business Current VAT flat rate (%)
Accountancy or book-keeping 14.5
Advertising 11
Agricultural services 11
Any other activity not listed elsewhere 12
Architect, civil and structural engineer or surveyor 14.5
Boarding or care of animals 12
Business services not listed elsewhere 12
Catering services including restaurants and takeaways 12.5
Computer and IT consultancy or data processing 14.5
Computer repair services 10.5
Entertainment or journalism 12.5
Estate agency or property management services 12
Farming or agriculture not listed elsewhere 6.5
Film, radio, television or video production 13
Financial services 13.5
Forestry or fishing 10.5
General building or construction services* 9.5
Hairdressing or other beauty treatment services 13
Hiring or renting goods 9.5
Hotel or accommodation 10.5
Investigation or security 12
Labour-only building or construction services* 14.5
Laundry or dry-cleaning services 12
Lawyer or legal services 14.5
Library, archive, museum or other cultural activity 9.5
Management consultancy 14
Manufacturing fabricated metal products 10.5
Manufacturing food 9
Manufacturing not listed elsewhere 9.5
Manufacturing yarn, textiles or clothing 9
Membership organisation 8
Mining or quarrying 10
Packaging 9
Photography 11
Post offices 5
Printing 8.5
Publishing 11
Pubs 6.5
Real estate activity not listed elsewhere 14
Repairing personal or household goods 10
Repairing vehicles 8.5
Retailing food, confectionery, tobacco, newspapers or children’s clothing 4
Retailing pharmaceuticals, medical goods, cosmetics or toiletries 8
Retailing not listed elsewhere 7.5
Retailing vehicles or fuel 6.5
Secretarial services 13
Social work 11
Sport or recreation 8.5
Transport or storage, including couriers, freight, removals and taxis 10
Travel agency 10.5
Veterinary medicine 11
Wholesaling agricultural products 8
Wholesaling food 7.5
Wholesaling not listed elsewhere 8.5

 

You should select which category is the best fit for your business and it should reflect the activity that generates the highest level of sales. Make a note somewhere as to the reasons you have chosen that category should you ever need to show this to HMRC.

Of great benefit is that if you join the flat rate scheme within your first year of VAT registration, then a discount of 1% is applied to your FRS percentage for up to the first 12 months of the VAT registration. However, if you’ve already been VAT registered for more than a year before you join then the discount doesn’t apply.

 

Make sure you have read our updated article on Limited Cost Traders, a new flat rate category which comes in from April 2017 – the article can be found HERE

 

VAT on costs

As well as the Flat Rate category, another key factor in deciding whether the flat rate scheme is right for you will be the level of VAT you have on your costs.

By being on the flat rate scheme you cannot claim VAT back on your costs (there is one exception, see below) so if you have quite a lot of VAT on your costs the flat rate scheme might not be right for you (you can get our free flat rate scheme calculator further down this article which will crunch the calculations for you).

One exception to not being able to claim costs is that if you have a single purchase of capital goods or equipment where the total cost of the purchase including VAT is £2,000 or greater, then you can claim the VAT back on the flat rate scheme.

This exception only applies to goods and equipment not to services.

So for example a purchase of a computer for over £2,000 would be eligible and you could claim the VAT back. More information from HMRC can be found HERE on this.

VAT Flat Rate Scheme Pitfalls

There are various things to be aware of with the HMRC flat rate VAT scheme, we have listed some of them below but we would always suggest discussing your circumstances with an experienced advisor before making any decisions.

  • Make sure you apply the flat rate % to the total gross turnover, not the lower net turnover
  • Make sure you’re aware of the new category of Limited Cost Trader which comes in from April 2017
  • If you are a sole trader be careful as other income you have such as rental income could be brought into your VAT flat rate scheme calculation
  • If you make zero rated or exempt sales or you sell abroad there are complications to be aware of
  • If you control another business you may not be allowed to use the flat rate scheme
  • If you expect your turnover to be over £150,000 in the next 12 months you are not allowed to join the flat rate scheme
  • You will have to leave your scheme once your turnover gets above the upper threshold which is currently £230,000 including VAT

These are just some of the pitfalls to be aware of, we suggest reading HMRC’s guide HERE

You also need to realise that by being VAT registered you will be charging VAT on your sales – you need to think about whether or not there is any commercial negative impact on you being VAT registered and whether your clients will be able to claim the VAT back that you charge them. This is a key thing to consider before voluntarily registering for VAT.

VAT Flat Rate Scheme vs Standard Scheme Calculator

We have designed a free excel calculator which allows you to compare the HMRC flat rate VAT scheme to the standard scheme for your circumstances and will show you if the flat rate scheme results in more profit or not.

Although it is an Excel spreadsheet, if you use Numbers (Mac) or Google Docs you will be able to convert it easily into those formats.

We hope you have found this article about the VAT Flat Rate Scheme useful.

Disclaimer