The Flat Rate for VAT Scheme was introduced by the Government to simplify the VAT rules for small business. If you have reasonable grounds to believe the value of your company’s taxable supplies in the next 12 months will be less than £150,000 (exclusive of VAT), your company is eligible to account for VAT using the flat rate scheme.
All invoices under the flat rate scheme continue to be raised with VAT charged at the appropriate rate, but the way in which a business accounts for VAT to HMRC changes. Instead of working out your output against your input VAT on a quarterly return you select from a list published by HMRC, a percentage based upon the category of business into which your company’s activity falls. This percentage is then applied to the company’s VAT inclusive turnover. This value is what the company accounts for to HMRC in each VAT quarter.
Your company invoices and receives VAT at the standard rate but pays VAT calculated at its flat rate percentage to HMRC. A company in its first year of VAT registration is allowed an additional 1% reduction on its percentage rate lasting for one year from the VAT effective date.
Joining the Flat Rate Scheme for VAT
You can apply at the time you register your company for VAT, or any time later. If you apply near the time of your VAT registration, you can start using the scheme from the date you are registered for VAT. Keep a copy of your application with a note of the office you send it to. HMRC will notify you in writing if your application is successful informing you of the date you can start to use the scheme. This is normally the start of the VAT period following receipt of your application.
Certain companies are not eligible to join the flat rate scheme; if they are eligible to join a VAT group (incorporated businesses which are linked to other incorporated businesses by common control or ownership), are an associate of another company, have been convicted of an offence in relation to VAT or in a VAT repayment position.
If a proportion of your supplies are exempt, therefore zero rated, it may not be beneficial to adopt the scheme.
Leaving the the Flat Rate Scheme for VAT
You must leave the scheme if you’re no longer eligible to be in it i.e. if :
- on the anniversary of joining, your turnover in the last 12 months was more than £230,000 (including VAT) - or you expect it to be in the next 12 months:
- you expect your total income in the next 30 days alone to be more than £230,000 (including VAT.
Once you leave the scheme you cannot rejoin it until twelve months have elapsed.
Considering the Flat Rate Scheme for VAT
There are two main benefits in adopting the scheme; time saved recording quarterly VAT on sales and purchases with the removal of any stress that may bring and; better cash-flow management as you can easily calculate in advance how much VAT you owe on takings.
Service companies with low purchases and expenses can achieve a financial saving. Be careful though as it’s not beneficial for all companies. If you operate in the service sector and make significant purchases, such as none reimbursable accommodation costs, adopting the scheme may see your company financially worse off.
The saving that arises is not simply the difference between the flat rate and standard rate VAT applied to VAT exclusive income. The flat rate is applied to VAT inclusive income. By entering the scheme your company loses its ability to reclaim VAT on the majority of goods or services used in the course or furtherance of your business
Before adopting the Flat Rate for VAT Scheme you must consider the VAT lost on expenses and purchases against the benefit of calculating VAT using the relevant flat rate scheme percentage. Your company may still recover VAT incurred on capital assets it purchases with a VAT inclusive value of more than £2,000 (with the exception of company cars).
The following illustration looks at a company providing Civil Engineering services with business turnover of £60,000 per annum. Accommodation costs are £4,000 per annum not reimbursed by the company’s clients. Accountancy fees are £1,500 + VAT per annum.
VAT inclusive turnover is £72,000 (£60,000 + £12,000 VAT).
VAT inclusive purchases are £6,600.00 (£4,000 + £1,500 + £1,100.00 VAT).
Under standard rate VAT the amount of VAT payable is £10,900 (£12,000 less £1,100).
Under the Flat Rate Scheme for VAT applying a rate of 14.5% the VAT payable would be £10,440 (VAT inclusive turnover £72,000 x 14.5%). In this instance the company makes a saving of £460 (£10,900 - £10,440) compared to the standard VAT calculation.
With the first year 1% allowance the rate is reduced to 13.5% so the VAT payable would be £9,720 (VAT inclusive turnover £72,000 x 13.5%). In this instance the company makes a saving of £1,180 (£10,900 - £9,720).
Any saving is treated as income in the company with the corporation tax applied to any profit arising.
The correct percentage rate for your company
The profession or activity of the individual or company, not the industry in which this services are provided, determines the percentage rate. HMRC issues guidance on the appropriate rate and requires that your choice is reasonable. You are best placed to determine what is the appropriate rate for your profession or activity. Keep a record of why you chose your sector as HMRC will not normally check your choice when processing your application. If you make a mistake you may pay too much tax, or too little and a shortfall could lead to an unexpected VAT bill at a later date.
Here are some example sector rates (from 4 January 2011): Engineer (including general, civil, structural) 14.5%; Computer, IT Consultancy or Data Processing 14.5%; Management Consultancy 14.0%.
A guide to working out your flat rate percentage and the VAT you need to pay on the Flat Rate Scheme is available from HMRC.