The Flat Rate VAT Scheme is designed to simplify VAT reporting for small businesses, but depending on your industry and expenses, it could either save you money or cost you more.
In this guide, we explain how the Flat Rate VAT Scheme works, who can use it, the advantages and disadvantages to consider, and how to decide whether it’s the right option for your business.
What is the Flat Rate VAT Scheme?
The Flat Rate VAT Scheme is a simplified way for eligible businesses to calculate and pay VAT to HMRC.
Instead of working out the exact VAT owed on every sale and purchase, businesses pay HMRC a fixed percentage of their VAT-inclusive turnover. The percentage used depends on the type of business or industry.
Businesses on the scheme still charge customers the normal VAT rate, usually 20%, but the amount paid to HMRC is calculated using the flat rate percentage instead.
One important point to understand is that businesses using the Flat Rate VAT Scheme usually cannot reclaim VAT on most purchases or expenses. This is because the flat rate percentage is designed to account for VAT on business costs.
How the Flat Rate VAT Scheme Works
Under the scheme:
- you charge VAT to customers as normal,
- customers still pay the full VAT amount,
- you apply your flat rate percentage to your VAT-inclusive turnover,
- you pay that amount to HMRC.
The difference between the VAT collected and the amount paid to HMRC is intended to help cover VAT on your business expenses.
The scheme is often most beneficial for businesses with relatively low VAT costs and straightforward accounting needs.
Example of the Flat Rate VAT Scheme
Here’s a simple example of how the scheme works.
A business invoices a customer:
- £1,000 for services
- plus £200 VAT
- total invoice value = £1,200
If the business uses a flat rate percentage of 14.5%, the VAT due to HMRC would be:
£1,200 × 14.5% = £174
The business keeps the remaining difference between the VAT charged and the amount paid to HMRC.
This retained amount is intended to contribute towards the VAT paid on business expenses that cannot usually be reclaimed separately under the scheme.
Who Can Join the Flat Rate VAT Scheme?
The Flat Rate VAT Scheme is designed for smaller VAT-registered businesses that want a simpler way to manage VAT.
Eligibility Rules
To join the Flat Rate VAT Scheme:
- your VAT-taxable turnover must be £150,000 or less excluding VAT,
- you must be VAT-registered,
- and you must expect your turnover to stay below the threshold over the next 12 months.
Once on the scheme, you must leave if your total business income exceeds £230,000 including VAT.
Some businesses may also be unable to join if they have recently left the scheme, committed VAT offences, or use certain other VAT accounting schemes.
Businesses That Commonly Use the Scheme
The Flat Rate VAT Scheme is often used by service-based businesses with relatively low running costs.
Examples include:
- consultants,
- IT contractors,
- marketing agencies,
- freelancers,
- designers,
- small professional service businesses.
Businesses with lower VATable expenses often benefit the most because they are less affected by the restriction on reclaiming VAT on purchases.
Flat Rate VAT Percentages by Industry
The flat rate percentage you use depends on your main business activity.
Some common examples include:
| Industry | Flat Rate % |
| Accountancy or bookkeeping | 14.5% |
| IT consultancy or data processing | 14.5% |
| Management consultancy | 14% |
| Marketing or advertising | 11% |
| Catering services and takeaways | 12.5% |
| Hairdressing or beauty services | 13% |
| Retailing not listed elsewhere | 7.5% |
HMRC publishes a full list of Flat Rate VAT percentages on GOV.UK, and businesses should ensure they are using the category that best matches their main business activity.
Limited Cost Trader Rules
The limited cost trader rules are one of the most important parts of the Flat Rate VAT Scheme and are often overlooked by businesses joining the scheme for the first time.
What is a Limited Cost Trader?
The limited cost trader rules were introduced by HMRC to prevent businesses with very low running costs from gaining excessive financial benefit from the Flat Rate VAT Scheme.
A business is usually treated as a limited cost trader if it spends very little on relevant goods.
If the rules apply, the flat rate percentage increases to 16.5%, regardless of your industry.
For many businesses, this removes most of the financial benefit of using the scheme.
How the Limited Cost Trader Test Works
A business will usually be classed as a limited cost trader if spending on relevant goods is:
- less than 2% of VAT-inclusive turnover,
- or more than 2% of turnover but less than £1,000 per year.
Relevant goods generally include physical business goods used by the business, but many purchases do not count, including:
- food or drink for staff,
- vehicles and fuel,
- capital assets,
- most services,
- rent, software subscriptions, or utilities.
This means many service-based businesses fall within the limited cost trader rules, including consultants, contractors, and freelancers with minimal business purchases.
Before joining the Flat Rate VAT Scheme, it’s important to check whether the limited cost trader rate would apply, as it can significantly reduce or remove any savings.
Advantages of the Flat Rate VAT Scheme
For some businesses, the Flat Rate VAT Scheme can simplify VAT administration and improve efficiency.
Simpler VAT Administration
The scheme reduces the need to calculate VAT on every business purchase, which can make bookkeeping and VAT returns simpler to manage.
This can save time, particularly for smaller businesses with straightforward finances.
Improved Cash Flow
Some businesses may pay less VAT to HMRC than they collect from customers, allowing them to retain part of the difference.
This can provide a modest cash flow benefit depending on the flat rate percentage and the business’s expenses.
Easier Budgeting
Using a fixed VAT percentage can make it easier to estimate VAT costs and manage cash flow throughout the year.
Less Risk of VAT Calculation Errors
Because the scheme uses a fixed percentage, there is generally less detailed VAT calculation involved, which may reduce the risk of certain reporting errors.
Disadvantages of the Flat Rate VAT Scheme
Although the scheme can simplify VAT reporting, it is not always the most cost-effective option.
Cannot Usually Reclaim VAT on Purchases
Businesses using the Flat Rate VAT Scheme usually cannot reclaim VAT on most purchases or expenses.
The main exception is certain capital assets costing more than £2,000 including VAT.
This can make the scheme less beneficial for businesses with significant running costs or regular VATable purchases.
Limited Cost Trader Rules Reduce Savings
Businesses caught by the limited cost trader rules must use the higher 16.5% flat rate percentage.
For many low-expense service businesses, this greatly reduces the financial advantage of the scheme.
May Cost More Than Standard VAT Accounting
The Flat Rate VAT Scheme is not always cheaper than standard VAT accounting.
Businesses that often find standard VAT accounting more beneficial include:
- product-based businesses,
- businesses with high expenses,
- businesses purchasing stock or equipment regularly,
- businesses reclaiming large amounts of VAT on purchases.
Before joining the scheme, it’s usually worth comparing the potential VAT cost under both methods.
Can You Reclaim VAT on Purchases?
One of the biggest differences between the Flat Rate VAT Scheme and standard VAT accounting is how VAT on purchases is treated.
In most cases, businesses using the Flat Rate VAT Scheme cannot reclaim VAT on day-to-day purchases or expenses.
This includes things such as:
- software subscriptions,
- office supplies,
- travel costs,
- utilities,
- professional fees,
- stock and materials.
This is because the flat rate percentage is designed to account for VAT on business expenses within the fixed rate paid to HMRC.
The £2,000 Capital Asset Exception
There is an important exception for certain capital asset purchases costing £2,000 or more including VAT.
In these cases, businesses may be able to reclaim VAT separately.
Examples can include:
- computers,
- machinery,
- office equipment,
- specialist tools or equipment.
The purchase must usually be a single capital asset purchase and not grouped smaller purchases or services.
First-Year 1% Discount
Businesses joining the Flat Rate VAT Scheme receive a 1% reduction on their flat rate percentage during their first year of VAT registration.
This discount applies for the first 12 months from the date the business becomes VAT registered, not from the date the scheme is joined.
For example:
- a business with a normal flat rate of 14.5%
- would pay 13.5% during its first year.
This temporary discount can make the scheme more beneficial for newly VAT-registered businesses.
How to Join the Flat Rate VAT Scheme
Businesses can apply to join the scheme through HMRC once they are VAT registered.
How to Apply
Applications are usually made through your online VAT account or by contacting HMRC directly.
When applying, businesses choose the date they want to start using the scheme. HMRC will then confirm the effective start date.
It’s important to ensure the correct industry percentage is being used from the beginning.
When Businesses Usually Join
The Flat Rate VAT Scheme is commonly used by:
- newly VAT-registered businesses,
- contractors and freelancers,
- consultants,
- businesses with relatively low overheads,
- service-based businesses with simple VAT reporting needs.
For some businesses, joining early can simplify VAT administration from the outset.
When Should You Leave the Scheme?
The Flat Rate VAT Scheme is not always the best long-term option for every business.
Leaving Voluntarily
Businesses can leave the scheme voluntarily if it is no longer financially beneficial or if standard VAT accounting becomes more suitable.
This often happens when:
- business expenses increase,
- more VAT is being paid on purchases,
- turnover grows,
- the limited cost trader rules reduce savings.
Mandatory Exit Threshold
Businesses must leave the scheme if their total income exceeds £230,000 including VAT.
If this threshold is exceeded, HMRC must be notified and the business will move back to standard VAT accounting.
Moving Back to Standard VAT Accounting
A business can move back to standard VAT accounting at any time if preferred.
This allows businesses to calculate VAT using the normal method and reclaim VAT on eligible purchases and expenses again.
Flat Rate VAT Scheme vs Standard VAT Accounting
The Flat Rate VAT Scheme can simplify VAT reporting, but it is not always the most cost-effective option.
The right choice depends on how your business operates, your industry, and how much VAT you typically pay on expenses and purchases.
| Flat Rate VAT Scheme | Standard VAT Accounting |
| Simpler VAT calculations | More detailed bookkeeping |
| Fixed VAT percentage | VAT calculated on actual sales and purchases |
| Limited ability to reclaim VAT | Full VAT reclaim on eligible purchases |
| Often suits low-expense businesses | Often suits higher-expense businesses |
| Easier VAT administration | More detailed VAT reporting |
| May improve cash flow for some businesses | More accurate reflection of actual VAT costs |
The Flat Rate VAT Scheme is often more attractive for smaller service-based businesses with relatively low overheads.
Standard VAT accounting is often more beneficial for businesses with significant expenses, stock purchases, equipment costs, or large amounts of reclaimable VAT.
The best option depends on your industry, expenses, and whether you qualify as a limited cost trader.
Common Flat Rate VAT Mistakes
Although the Flat Rate VAT Scheme is designed to simplify VAT reporting, businesses can still make costly mistakes if the rules are misunderstood.
Using the Wrong Industry Percentage
Businesses must use the flat rate percentage that best matches their main business activity.
Using the wrong category can lead to incorrect VAT payments and potential issues with HMRC.
Forgetting the Limited Cost Trader Rules
Many businesses incorrectly assume they qualify for their normal industry rate without checking the limited cost trader rules.
If the rules apply, the business may need to use the higher 16.5% rate instead.
Reclaiming VAT Incorrectly
Businesses on the Flat Rate VAT Scheme usually cannot reclaim VAT on most purchases or expenses.
Incorrect VAT reclaims are one of the most common Flat Rate Scheme errors.
Failing to Monitor Turnover Thresholds
Businesses must monitor their turnover carefully while using the scheme.
If total income exceeds the £230,000 VAT-inclusive threshold, the business must leave the Flat Rate VAT Scheme.
Not Reviewing Whether the Scheme Is Still Beneficial
The Flat Rate VAT Scheme may work well when a business first starts, but it may become less beneficial over time as expenses, purchases, or turnover increase.
Regularly reviewing your VAT position can help ensure you are still using the most suitable VAT scheme for your business.
Need Help Choosing the Right VAT Scheme?
Choosing the right VAT scheme can make a significant difference to your business’s cash flow, admin workload, and overall VAT position.
At Ryans, we help businesses understand which VAT scheme is most suitable for their circumstances and ensure VAT is managed accurately and efficiently.
Our VAT services include:
- VAT registration assistance
- Flat Rate VAT Scheme advice
- VAT return preparation and support
- Limited cost trader reviews
- VAT planning and administration
- VAT control and reconciliation
- Support with switching VAT schemes
- Ongoing VAT compliance support
- Help dealing with HMRC VAT queries and disputes
Whether you’re registering for VAT for the first time or reviewing whether the Flat Rate VAT Scheme is still right for your business, our team can help simplify the process and reduce the risk of costly VAT mistakes.
To discuss your VAT requirements, contact Ryans today.
Flat Rate VAT Scheme FAQs
Is the Flat Rate VAT Scheme worth it?
It depends on your business type, expenses, and VATable costs.
The scheme can work well for some low-expense service businesses, but it may be less beneficial for businesses with high running costs or those affected by the limited cost trader rules.
Can I reclaim VAT on purchases?
Usually not.
Businesses using the Flat Rate VAT Scheme generally cannot reclaim VAT on most purchases or expenses, except for certain capital assets costing more than £2,000 including VAT.
What is a limited cost trader?
A limited cost trader is a business that spends very little on relevant goods.
If the limited cost trader rules apply, the business must use the higher 16.5% flat rate percentage instead of its normal industry rate.
Can sole traders use the scheme?
Yes. Sole traders, partnerships, and limited companies can all use the Flat Rate VAT Scheme if they meet HMRC’s eligibility requirements.
Can limited companies use the scheme?
Yes. Many small limited companies use the Flat Rate VAT Scheme, particularly service-based businesses with lower overheads.
Do I charge customers normal VAT?
Yes. Businesses on the Flat Rate VAT Scheme still charge customers VAT at the normal applicable rate, usually 20%.
The flat rate percentage is only used to calculate how much VAT is paid to HMRC.
Can I leave the scheme at any time?
Yes. Businesses can leave the Flat Rate VAT Scheme voluntarily if it is no longer beneficial or if standard VAT accounting becomes more suitable.
Is the Flat Rate VAT Scheme good for contractors?
It can be, but many contractors are affected by the limited cost trader rules, which may reduce or remove the financial benefit of the scheme.
It’s usually worth reviewing the figures carefully before joining.