Flat Rate VAT Scheme Guide

Significant changes are being made to the VAT Flat Rate Scheme from the 1st April 2017.

For many contractors who incur limited direct costs, the scheme has provided a  great cash benefit. For example, if the contractor invoiced a client £15,000 in a VAT quarter, the contractor would have have charged the client a further £3,000 in VAT. If we use the example of an IT contractor with a FRS rate of 14.5%, then the contract would pay over to HMRC (18,000 x 14.5%) £2,610. Therefore the contractor would keep £390.

If the contractor incurred very little VAT chargeable costs, then the FRS can provide a significant cash benefit!

The rules stated below for the Flat Rate Scheme still apply, but only if the business satisfies a new test as to whether it is a Limited cost business definition (LCBD). If it falls within the definition in each VAT period, then the FRS is restricted to 16.5%. In the IT contractor example, this would restrict the ‘cash benefit’ to only £30!

The new criteria will apply if the contractor’s VAT inclusive expenditure on goods is :

  • below 2% of their VAT inclusive turnover; or

  • more than 2% of their VAT inclusive turnover but less than £250 per quarter (£1000 per annum)

In order to be eligible for the Flat Rate Scheme your Turnover (Ex VAT) must be below £150,000. This has been the case prior to the changes in April 2017.

But what VAT expenditure is allowable for the 2% test?

It is only expenditure that is directly related to the goods and services provided. It does not include capital expenditure, or expenditure on services, such as advertising or promotion, or even the cost of your accountant!

I have attached some links below to HMRC websites fyi. The Helpful Bean Counter is also willing to help you if you require more information.

Check your VAT flat rate https://www.tax.service.gov.uk/check-your-vat-flat-rate/vat-return-period

VAT Notice 733 https://www.gov.uk/government/publications/vat-notice-733-flat-rate-scheme-for-small-businesses

If you are not restricted by the new test, then the FRS rules stated below can be applied:

The flat rate VAT scheme is an incentive provided by the government to help simplify taxes and means you charge VAT on your invoices (current rate 20%)

….but only pay back to HM Revenue and Customs at a lower rate!

for example IT Contractors (rates differ depending on your profession/trade – see table below) the rate in your first year is just 13.5% of the gross amount and 14.5% in subsequent years (you receive a 1% discount in your first year).

This provides the following additional income (based on a 45 week working year):

  • £200 per day contract – £1,710 extra per year

  • £350 per day contract – £2,992.50 extra per year

  • £600 per day contract – £5,130 extra per year

The FRS is therefore the chosen scheme for most Contractors, Freelancers, Consultants and Interim Managers. It is also the scheme that is recommended for businesses that have very few VAT chargeable purchases and expenses i.e. don’t buy much stock.

Important notes about the FRS:

  1. If you estimate that your annual turnover excluding VAT will exceed £150,000 in your first year, you shouldn’t join the scheme.

  2. If your annual turnover exceeds £230,000 of VAT inclusive revenue in subsequent years you must come off the scheme.

  3. Companies on the flat rate scheme are unable to claim back any VAT on purchased goods and expenses for their business.

You can however reclaim VAT on capital asset purchases over £2,000, for example a PC. Providing all the capital purchases are on the same receipt such as a PC, printer and scanner you can claim the VAT back on these items. You cannot however buy a PC one month for £1,500 then a printer the next month for £300 and a scanner the month after for £200 and add them together, they must all be on the same receipt. 

Like standard VAT, the flat rate scheme still requires you to complete a quarterly VAT return form (online only). You will need to charge the standard VAT rate, currently 20%, to your invoices, however…rather than accounting for the VAT on every payment, when you do your quarterly report you will only pay a single flat rate percentage on your turnover of each quarter.

The VAT percentage you pay is considerably lower than that of the standard VAT rate,(see below table for a full list of the standard rates depending on your profession) you then keep the difference as your profit. See example below based on a Limited Company specialising in IT:

Net amount you invoice your client

 £5,000

VAT charged on top to your client (20%)

 £1,000

Gross Amount  

 £6,000

Flat rate VAT 13.5% (this includes a first year discount of 1%)

 13.5%

VAT to be paid to HMRC – 13.5% of £6,000

 £810

VAT received from client  

 £1,000

Profit for you i.e. what you get to keep   

 £190

Advantages of using the Flat Rate Scheme

  • The ability to earn money from VAT, you can earn thousands of pounds extra each year simply out of VAT (the government does this as the FRS is simple for them to manage and you are in affect acting as a tax collector).

  • A reduced amount of paperwork to handle as you are not submitting any of your input costs to HMRC all you need to do is keep the receipts from your purchases.

  • If you are a new business, using the flat rate scheme in your first year, you receive a further 1% decrease on the overall percentage tax you pay each quarter.

Disadvantages of using the Flat Rate Scheme

  • If you are buying lots of stock or have high VAT chargeable expenses you will miss out on reclaiming the VAT.

  • If you are incurring high travel and hotel costs whilst carrying out a contract. In some situations it may be more beneficial to not be on FRS.

  • If you decide to stop your FRS election it is not possible to go back to the scheme for 12 months. So only change your election if there has been a significant change to your circumstances.

Hopefully we’ve now covered some of the basics of the Flat Rate VAT Scheme, however should you have any further questions please do not hesitate contact us on 02393 110395  or email: info@helpfulbeancounter.co.uk  

Flat Rate Scheme percentage rates from 2nd January 2014:  

Category of business

Appropriate percentage

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 that are 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

Dealing in waste or scrap

10.5

Entertainment or journalism

12.5

Estate agency or property management services

12

Farming or agriculture that is 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 that is 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, confectionary, tobacco, newspapers or children’s clothing

4

Retailing pharmaceuticals, medical goods, cosmetics or toiletries

8

Retailing that is 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 that is not listed elsewhere

8.5

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