We are often asked by business owners if the Flat Rate VAT scheme is profitable for their business. If the question ”The Flat Rate VAT is it good for my business ?” has been on your mind a lot lately, then you have come to the right place, because in this article we will unpack this issue.
The Flat Rate VAT scheme is great for some businesses, but not so great for many others, such as most service based businesses. In this article we will explain why this is.
What is the Flat Rate VAT scheme and how does it work?
The Flat Rate VAT scheme is identical to the regular VAT scheme in that you charge VAT to your customers at the usual 20% rate (charging VAT to your customers is also known as “output VAT”) and you pay VAT to your suppliers when you buy goods and services from them (also known as “input VAT). So far, there is nothing new.
The fundamental difference between the regular VAT scheme described above and the Flat Rate VAT scheme is when you prepare your VAT return. Instead of adding up all the VAT you charge and deducting from it the VAT you spent on purchases, with the Flat Rate VAT scheme you add up all your sales, including the VAT you charged to your customers, and pay a percentage of those sales to HMRC. The percentage you pay depends on what your business trades in, unless you are a limited cost trader.
This means that it would only benefit your business if the amount you would owe HMRC if you paid regular VAT is higher than the percentage of your total sales that you pay under the Flat Rate VAT scheme.
This also means that you cannot claim a refund on your output VAT because the Flat Rate VAT scheme implies that you already pay lower than with the regular VAT scheme.
What is the percentage of sale you must pay to HMRC under the Flat Rate VAT scheme?
HMRC has set certain percentages depending on what your business trades in.
During the first year that your business is registered for VAT (which is not necessarily the same as the first year you’re on the VAT Flat Rate Scheme), you get a 1% discount on the percentages – so you would use, for example, 10% instead of 11% if you run an advertising business.
Please note that if you are a limited cost trader, the percentage of your total sales that you have to pay HMRC is 16.5% !
Is my business eligible for the Flat Rate VAT scheme?
If you are interested in joining the VAT Flat Rate Scheme, you can apply to HMRC provided your business meets certain criteria.
Your total estimated VATable sales (VATable sales are sales that your business will have to charge VAT on if it is registered for VAT) for the next year must be under £150,000 – this includes everything you plan to sell that is subject to VAT.
Once you join the scheme you can keep using it until your total business income goes above £230,000 a year.
You will be ineligible to join the VAT Flat Rate Scheme if:
- You have been in the scheme before and left it less than 12 months ago (you need to wait until a year has gone by before you can rejoin)
- You have been guilty of a VAT offence or charged a penalty for evading VAT within the last 12 months
- you use a second-hand margin scheme
- you are, or have been within the last 24 months, a member or potential member of a VAT group, or registered for VAT as a division of a larger business
- your business is closely associated with another business
What are the benefits of joining the Flat Rate VAT scheme?
According to HMRC, the Flat Rate Scheme makes your record-keeping simpler because you don’t have to work out what VAT you can claim on your purchases.
The Flat Rate Scheme can also save you money, though it’s not designed with this in mind. This tends to depend on what sector you are in and on how much VAT you pay out on your costs.
Is there a downside to the Flat Rate VAT scheme?
Unfortunately some business owners see the shiny low percentage used with the Flat Rate VAT scheme and think that is really great because they are going to pay HMRC a lot less in tax, but many miss the small print and then get themselves into loads of trouble with HMRC.
As with many good tax saving opportunities, the government eventually realized that they are missing out on potential tax and stopped them! In April 2017 it was the Flat Rate VAT scheme that they changed in a way that prevented many businesses to avail of it in a way that would be profitable to them.
HMRC brought in something called low cost trader or limited cost business. This basically means that in order to use the low percentage rate for your industry, you need to spend a certain amount on physical, movable goods in your business. And if you don’t spend enough, then you are a low cost trader and need to use a higher percentage – which actually means you’d be worse off than using the normal VAT rules.
What is a limited cost trader?
You are a low cost trader or limited cost trader if the amount you spend on relevant goods including VAT is either:
- less than 2% of your VAT flat rate turnover (sales figure)
- greater than 2% of your VAT flat rate turnover (sales figure) but less than £1,000 per year
So for example, if your sales are £10,000 per year, then you need to spend over £200 per year on relevant goods or you’d be classed as a low cost trader.
Now this doesn’t sound like a lot – but think about what you actually do spend money on – especially if you’re a service based business. And the list of what counts isn’t very big when you look at what you spend your money on!
What are classed as relevant goods for the limited cost trader?
Relevant goods are moveable items or materials exclusively used in your business. You can also include gas and electricity. If you are estimating your annual spend then you need to use realistic figures.
It may be easier to start with what isn’t classed as relevant goods:
- any services – which is anything that isn’t goods
- expenses like travel and accommodation
- food and drink eaten by yourself or your team
- vehicle costs including fuel unless you’re in the transport business using your own, or a leased vehicle
- rent, internet, phone bills and accountancy fees
- gifts, promotional items and donations
- goods you will resell or hire out unless this is your main business activity
- training and memberships
- capital items for example office equipment, laptops, mobile phones and tablets
Here are some examples of relevant goods:
- stationery and other office supplies to be used exclusively for the business
- gas and electricity used exclusively for your business
- fuel for a taxi owned by a taxi firm
- stock for a shop
- cleaning products to be used exclusively for the business
- hair products to use to provide hairdressing services
- standard software, provided on a disk – if anyone actually does this anymore??
- food to be used in meals for customers
- goods provided by a subcontractor and itemised separately
- goods brought into the UK if they are not otherwise excluded
- goods bought without VAT being charged, if they are not otherwise excluded – ie they don’t qualify for VAT (like stamps) or the person you’re buying from isn’t VAT registered (and therefore doesn’t charge you VAT)
Please note – this is not a full list but the most common goods under the scheme.
What percentage do I use if I am a low cost trader?
The rate for a low cost trader is 16.5% – which doesn’t sound too bad – it’s better than 20% right?! But when you actually do the math you realize that you end up paying more than if you took your 20% charged on sales less your 20% of all your VAT purchases. So therefore we’d totally recommend just sticking to the standard way of doing VAT (although maybe use the cash version if you sell on credit and it takes a while for your clients to pay you – and you’re eligible of course!).
What if I am using the wrong percentage of the Flat Rate VAT scheme?
First off – don’t panic – at LAS Accounting we can fix this for you, but unfortunately it could mean having to pay a bit extra over to HMRC. We have had a few clients fall into this trap before they joined us, so you are not alone and it is fixable. And HMRC won’t expect you to pay the extra tax in one go – especially if it goes back a while. You will be able to set up a payment plan to ease the burden on your cashflow.
Should I avoid the Flat Rate VAT scheme?
Because flat rate taxable sales include VAT-exempt sales, it is probably not a good idea to join the scheme if you make a lot of exempt sales, as you might end up paying more in VAT.
If you make a lot of zero-rated sales or if you buy a lot of standard-rated goods and services, joining the scheme is likely to cost you more in VAT. Businesses not on the Flat Rate Scheme would normally get a repayment from HMRC each quarter, which they would lose if they joined the scheme.
How can LAS Accounting help ?
We’ve got you covered, don’t stress ! We totally understand that getting the right way of doing VAT is confusing, and you certainly didn’t set up your business to work out how to do your VAT returns! But we did – so let us take this stress off your shoulders so you can focus on what you do love to do. We can help make sure you are set up in the right way so it doesn’t come back and bite you down the line.
Get in touch with us, fill in the quick questionnaire and we can make sure you are doing your VAT in the right way and keeping HMRC off your back.