The Flat Rate Scheme simplifies VAT by charging a fixed percentage of your gross turnover. Here is how the rates work, the limited cost trader trap, and how to decide whether it saves you money.
The Flat Rate VAT Scheme is HMRC's attempt to make VAT simpler for small businesses. Instead of tracking the VAT on every sale and every purchase, you pay HMRC a single fixed percentage of your gross turnover. For some businesses, particularly those with low costs and a favourable sector rate, it can save both time and money. For others, especially since the 2017 limited cost trader rules, it can quietly cost more than standard VAT accounting. Knowing which camp you fall into is the whole game.
The scheme only becomes relevant once you are VAT-registered, which happens when your taxable turnover crosses the VAT registration threshold of £90,000, or when you choose to register voluntarily. Once registered, the Flat Rate Scheme is one of several ways you can account for VAT, and it is entirely optional.
Under normal (standard) VAT accounting, you add up the VAT you charged customers (output VAT), subtract the VAT you paid on purchases (input VAT), and pay HMRC the difference. The Flat Rate Scheme replaces that with a single calculation: you take your VAT-inclusive turnover for the period and multiply it by your sector's flat rate percentage. That is what you pay HMRC.
Two things catch people out. First, you still charge your customers the normal 20% VAT and issue normal VAT invoices; the flat rate only changes what you hand over. Second, the percentage is applied to your gross (VAT-inclusive) turnover, not your net sales, which is why a 12% flat rate is not as generous as it first sounds.
In exchange for the simplicity, you generally cannot reclaim VAT on your purchases. The one notable exception is capital assets costing more than £2,000 including VAT in a single purchase, such as a laptop or machinery, where you can reclaim the VAT separately.
The flat rate percentage you use depends on your trade sector. HMRC publishes a list of rates ranging from around 4% to 14.5%. A few illustrative examples:
| Business type | Flat rate |
|---|---|
| Retailing food, confectionery, newspapers | 4% |
| Computer and IT consultancy | 14.5% |
| Management consultancy | 14% |
| Hairdressing or other beauty treatment | 13% |
| Estate agency or property management | 12% |
| General building or construction (labour only) | 14.5% |
| Catering including restaurants and takeaways | 12.5% |
You choose the sector that best describes your main business activity. If you genuinely span more than one, you pick the one that accounts for the largest share of your turnover.
As an incentive, HMRC reduces your flat rate by 1 percentage point for the first 12 months from the date you register for VAT. So an IT consultant on the 14.5% rate pays just 13.5% during their first year. This discount applies once, and only to your first year of VAT registration.
The single most important thing to understand about the Flat Rate Scheme today is the limited cost trader rule, introduced in April 2017 to close a loophole.
If your business spends very little on goods, specifically less than 2% of your turnover, or less than £1,000 a year, on relevant goods, you are classed as a limited cost trader and must use a flat rate of 16.5%, regardless of your sector. Relevant goods exclude services, food and drink consumed by you or staff, vehicles and fuel (with limited exceptions), and capital items.
At 16.5% of gross turnover, the scheme leaves a limited cost trader handing over almost all the VAT they collect, so it is usually no better, and sometimes worse, than standard VAT accounting where they could at least reclaim some input VAT. Many service-based contractors and consultants who joined the scheme before 2017 found themselves pushed into the 16.5% rate and left as a result.
The scheme tends to favour businesses that:
It tends to work against businesses with high VATable costs (lots of materials, equipment or subcontractors charging VAT), because the lost input VAT reclaim outweighs the simplicity, and against any business that falls into the 16.5% limited cost trader rate.
Example 1: A favourable case. Sofia runs a small catering business with gross (VAT-inclusive) quarterly turnover of £24,000. Her sector rate is 12.5%. She spends well over 2% of turnover on food and ingredients, so she is not a limited cost trader.
Example 2: A limited cost trader. Raj is an IT consultant with gross quarterly turnover of £24,000 and almost no spending on goods, so he is a limited cost trader on the 16.5% rate.
These two examples show why the scheme is not a one-size-fits-all win. Running the numbers for your own turnover and costs is essential, and the VAT calculator is a quick way to check the standard-accounting figures for comparison.
You can join the Flat Rate Scheme if you expect your VAT-taxable turnover (excluding VAT) to be £150,000 or less in the next 12 months. You must leave the scheme once your total business income (including VAT) exceeds £230,000, or if you expect it to exceed that in the next 30 days. These limits are separate from the £90,000 registration threshold, so you can be registered for VAT but ineligible for the Flat Rate Scheme if you are too large.
To join, you apply to HMRC, usually as part of your VAT registration or via your business tax account. Because the Flat Rate Scheme is still a VAT scheme, you remain within Making Tax Digital for VAT, so you must keep digital records and file your returns through compatible software, even though the calculation itself is simpler.
The Flat Rate Scheme sits on top of, not instead of, the standard VAT rules. You still register at the £90,000 VAT registration threshold, still charge customers the normal rate, and still file VAT returns. What changes is purely the internal calculation of what you owe and your loss of the input VAT reclaim.
It is also entirely separate from income tax and from Making Tax Digital for Income Tax. The VAT you pay under the Flat Rate Scheme is not an income tax deduction in the conventional sense, although the way you account for it in your business accounts affects your declared profit. For a sole trader, the flat rate effectively becomes part of the cost of doing business, and the simplicity it offers can be valuable for someone already juggling quarterly income tax updates and bank reconciliation.
The Flat Rate Scheme rewards simplicity, but only if your sector rate is kind and your costs are low. Since the 16.5% limited cost trader rate arrived, far fewer service businesses come out ahead, so always run the numbers before you join.
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