The Flat Rate Scheme is a highly simplified method of accounting for VAT and could save you money
A trader may join the scheme if there are reasonable grounds to believe that taxable turnover in the next year will be £150,000 or less. Taxable turnover is standard-rated, zero-rated or lower-rated sales.
HMRC have estimated the percentage of VAT due compared to the VAT inclusive turnover for different types of business.
The trader establishes which business category they belong to, and the relevant percentage is applied to tax inclusive turnover to arrive at the amount of VAT due. HMRC have introduced a further reduction of 1% off the normal flat rate percentages for businesses in their first year of VAT registration.
For example Accountants have a flat rate of 14.5%. The accountant would not need to change the way he invoiced his customers. However, when preparing his VAT return, the amount of VAT due will be VAT inclusive income times the flat rate percentage of 14.5%. There is no input tax reclaim under the scheme.
There is a new flat rate applicable to limited cost traders. Businesses are limited cost traders where their VAT inclusive expenditure on relevant goods is either:
- less than 2% of their flat rate turnover in a prescribed accounting period or
- greater than 2% of their flat rate but less than £1,000 per annum if prescribed accounting period is one year.
If the business meets either of the two conditions, it will need to use the 16.5% flat rate to calculate the amount of VAT due to HMRC under the scheme.
Note: even though the trader may be using FRS, he must still raise VAT invoices to customers in the customary way.
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Can I claim back VAT on expenses
Generally, VAT on expenses and supplier invoices is not deductible under the FRS. This is because the percent used in the calculation takes into account the VAT that would have been charged on expenses.
However, it is possible to deduct input tax in the following situations;
- The first instance includes capital assets costing less than £2,000 therefore, if a trader purchases a capital asset with a VAT inclusive value of more than £2,000, he will be entitled to a full input tax reclaim in respect of that capital asset.
- The other instance for an input tax reclaim is where a trader recovers pre-registration input tax. If a trader reclaims input tax in respect of pre-registration capital assets, when sold must be excluded from flat-rate turnover and VAT must be accounted for on the sale at the full rate of 20%.
The trader must leave the scheme if total tax inclusive turnover exceeds £230,000 in the previous trailing 12 months.
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In summary, the main workings of a Flat Rate scheme include the fact that VAT is charged on invoices at the standard rate as normal. As well as this, VAT paid over to HMRC is a flat percentage x VAT inclusive turnover. This VAT inclusive turnover includes turnover of Standard Rate, Zero Rate, exempt supplies, and capital assets. Finally, input VAT can only be recovered on capital assets costing less than £2,000 (inc VAT). The two main advantages of a Flat Rate Scheme are quarterly returns are much simpler to complete and secondly you are less likely to make errors on return.
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A record of the flat-rate calculation must be kept showing the flat rate turnover for the vat accounting period, the flat rate percentage used and the tax due. This record must be kept with the VAT account, thus easily inspected by HMRC. For business using FRS, the revenue expects annual accounts to be prepared using gross receipts less VAT paid to HMRC. Expenses should be shown inclusive of VAT as they would for any unregistered business.
Some traders are ineligible for the FRS this includes:
- Traders who use the second-hand margin scheme, the auctioneer’s scheme, or the Tour Operator margin scheme.
- Traders falling within the capital goods scheme.
- Where a trader has ceased to operate the FRS in previous 12 months.
- Where in the previous 12 months, the trader has been convicted of VAT offence or penalty for dishonesty.
- If within the past 24 months the trader was part of a VAT group.
- If trader is closely associated with another person – associated persons include cases where one business is under the dominant influence of another or two businesses are closely bound by financial, economic and organisational links.
This information is correct at time of writing, please refer to the government website for any updates. https://www.gov.uk/vat-flat-rate-scheme