Is the VAT Flat Rate Scheme Right for You?

The VAT Flat Rate Scheme sounds appealing on the surface. Instead of tracking VAT on every purchase and sale, you pay a fixed percentage of your gross turnover and keep the difference. It simplifies your bookkeeping and can save you money. But it is not right for everyone, and the maths is worth doing properly before you sign up.

Under the standard VAT scheme, you charge VAT at 20% on your sales and reclaim VAT on your business purchases. Your VAT liability is the difference between what you charge and what you reclaim. This requires detailed records of VAT on every transaction, which can be time-consuming for businesses with many small purchases.

The Flat Rate Scheme works differently. You still charge VAT at 20% on your invoices, but instead of calculating input and output VAT, you pay a flat percentage of your gross turnover to HMRC. The percentage varies by trade sector — for example, computer and IT consultants pay 14.5%, while food retailers pay 4%. In the first year of VAT registration, you get an additional 1% discount.

The scheme is designed to benefit businesses with low costs relative to their turnover. If you are a consultant or freelancer with few purchases — just a laptop, phone, and some software — the Flat Rate Scheme can save you money because the flat rate is lower than the 20% you charge minus the small amount you would reclaim.

However, there is a significant catch. Since April 2017, limited cost businesses — those whose goods purchases are less than 2% of turnover or less than £1,000 per year — must use a flat rate of 16.5%. This effectively eliminates the benefit for most service businesses. If you buy very few physical goods, you are almost certainly a limited cost business, and the 16.5% rate rarely saves money compared to the standard scheme.

To decide whether the Flat Rate Scheme works for you, do a simple calculation. Take your expected annual turnover and multiply it by your sector's flat rate percentage. Then calculate what you would pay under the standard scheme — 20% of your sales minus the VAT you could reclaim on purchases. Compare the two numbers. If the Flat Rate Scheme gives you a lower figure, it makes sense. If not, stick with standard VAT.

There are some other considerations. Under the Flat Rate Scheme, you cannot reclaim VAT on most purchases. The only exception is capital expenditure over £2,000 including VAT. So if you regularly make large purchases, you lose the ability to reclaim VAT on them, which can wipe out any savings from the flat rate.

The scheme also has a turnover cap. You must leave the scheme if your turnover exceeds £230,000 in the previous twelve months. If your business is growing, you might find yourself forced off the scheme at an inconvenient time. Planning for this transition is important.

From a bookkeeping perspective, the Flat Rate Scheme is genuinely simpler. You do not need to track VAT on individual purchases, which reduces your record-keeping burden. For businesses using MTD-compatible software like Accounted, VAT is handled automatically under either scheme, but the Flat Rate Scheme means fewer data entry points.

One final consideration: if you are planning significant capital expenditure — buying a vehicle, equipment, or machinery — the standard scheme lets you reclaim VAT on these purchases. Timing your switch between schemes around major purchases can save significant amounts.

The Flat Rate Scheme is a useful simplification for the right businesses. It works best for service businesses with turnover between the VAT threshold and about £150,000, with minimal goods purchases but enough to avoid the limited cost business rate. For everyone else, running the numbers both ways is essential before making a decision.