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Flat rate scheme, how does it work?

The flat rate VAT scheme is an incentive provided by the government to help simplify taxes and means you charge VAT on your invoices at 20% (2013) but only pay back HM Revenue and Customs at a lower rate. It is 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 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%, (2018) 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, you than 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

For more information on this scheme, visit our Flat Rate VAT Scheme Guide.