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By Lynne Gowers on 28th September 2018
Registering for VAT (value added tax) allows your business to claim the VAT back on VAT rated business expenses and charge VAT on your invoices.
There are various types of VAT schemes, depending on the nature and turnover of your business, but here we are looking specifically at the VAT flat rate scheme (FRS) and whether it is the appropriate option for your business.
The VAT flat rate scheme (FRS) is a simplified VAT scheme that enables VAT registered businesses to work out how much VAT they need to pay over to HMRC by applying a flat-rate percentage to their VAT-inclusive turnover.
However, VAT cannot be reclaimed on purchases (with an exception for certain capital assets over £2,000).
The flat rate percentage depends on the sector in which the business operates, and also whether it is classed as a “limited cost business”.
On standard VAT, the amount of VAT a business pays or claims back from HMRC is the difference between the VAT charged to its customers and the VAT it pays on its own purchases.
However, with the flat rate scheme you pay a fixed rate of VAT to HMRC and keep the difference between that and the amount of VAT you charge your customers.
A trader wishing to join the flat rate scheme must have VAT-exclusive turnover of £150,000 or less. An application to join the scheme can be made online here, or by post (on Form VAT600 FRS).
Once in the scheme, a trader can remain in it unless, on the anniversary of joining, their turnover was £230,000 or more in the last 12 months, or is expected to be £230,000 or more in the next 12 months. A trader must also leave the FRS if they expect their total income in the next 30 days to top £230,000.
The flat rate percentage depends on the sector in which the business operates.
A discount of 1% is given for the first year that the trader is in the scheme.
Where the trader is a limited cost business, the flat rate percentage is 16.5% (although they still get the 1% discount for the first year).
A limited cost business is one where the amount spent’ on “relevant goods” is either:
If the period is less than one year, the £1,000 threshold is proportionately reduced (so £250 per quarter).
What counts as “relevant goods” is set out in VAT Notice 733. It includes things like stationery, gas and electricity used in the business, stock, food used in meals sold to customers, fuel used by a taxi business and other similar costs.
It does not include services, such as accountancy and legal fees, downloadable software, rent, postage, and fuel other than where the business is in the transport sector.
One of the main advantages of the FRS is that working out the VAT to pay to HMRC is straight-forward. It is simply a case of multiplying the VAT-inclusive turnover for the quarter by the flat-rate percentage for the business sector.
To calculate VAT under the FRS, you first need to determine if you are a limited cost business.
If you are, you need to apply the flat rate percentage of 16.5% to the calculation (or 15.5% in the first 12 months after registering).
If you are not, you need to apply the correct flat rate percentage for your business sector.
VAT payable = FRS% x VAT inclusive turnover
You can find a free VAT calculator here
Paul runs an e-commerce retail business and has done for a number of years. For a particular VAT quarter, his VAT-inclusive turnover is £22,000. His flat rate percentage for his sector is 7.5% (his business is classed as “retailing not listed elsewhere”). He is not a limited cost business.
For the VAT quarter he must pay VAT of £1,650 over to HMRC (£22,000 @ 7.5%).
The main advantage is one of simplicity. The trader does not need to keep a record of VAT on purchases, although they still need to keep records for corporation tax purposes. The 1% discount in the first year may generate a welcome bonus.
However, it may be more costly being in the scheme, particularly for limited cost businesses, who get virtually no relief for any VAT they incur.
The flat rate percentage for a limited cost business is 16.5% of VAT-inclusive turnover, which is equivalent to 19.8% of VAT-exclusive turnover; consequently, a limited cost business pays over virtually all the VAT charged to customers to HMRC. Often limited cost traders actually incur more VAT than 0.2% of VAT-exclusive turnover, hence may be better off with a standard VAT rate scheme.
Deciding whether the VAT FRS is for you is a case of comparing what you will pay under the scheme with what would be payable under normal rules, and factor in the added convenience of the scheme.
Our free guide to registering for VAT goes into more detail on the types of VAT available, how to register, submitting VAT returns and making payments. You can download it by clicking on the link at the top of this post.
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