Charge VAT at 20% as usual, but pay HMRC a flat percentage of your gross takings. For some small businesses it cuts both admin and the VAT bill; for others it costs more.
For a small business, VAT admin can feel out of proportion to the sums involved: every receipt scrutinised, every input VAT claim logged. The Flat Rate Scheme was designed to cut through that. Instead of the usual output-minus-input calculation, you hand HMRC a fixed slice of your takings and keep the rest. Whether that is a good deal depends entirely on the numbers.
Under the standard VAT rules, you charge 20% on sales, reclaim VAT on purchases, and pay HMRC the difference. The Flat Rate Scheme replaces that with one step: you still charge customers the normal 20%, but you pay HMRC a fixed percentage of your gross turnover, the total including the VAT you charged.
The flat percentage depends on your trade sector and is set by HMRC. A few illustrative rates: business services not listed elsewhere 12%, IT consultancy 14.5%, hairdressing 13%, and a general retailer of goods around 7.5%. In your first year of VAT registration you get a 1% discount off your sector rate, a useful sweetener for new businesses.
The major catch is that you cannot reclaim input VAT on most purchases. The flat percentage is supposed to already account for the input VAT you would normally claim. The one exception is capital assets, such as equipment or machinery, costing £2,000 or more including VAT, on which you can still reclaim input VAT separately.
Daniel is a self-employed IT consultant, VAT-registered, with a sector flat rate of 14.5%. In a quarter he invoices clients £30,000 plus £6,000 VAT, so his gross turnover is £36,000. His input VAT on the few purchases he makes is just £400.
Under the Flat Rate Scheme:
| Item | Amount |
|---|---|
| Gross turnover (incl. VAT) | £36,000 |
| Flat rate | 14.5% |
| VAT paid to HMRC | £5,220 |
He charged clients £6,000 of VAT but pays HMRC only £5,220, keeping the £780 difference as extra income (which is itself taxable). He cannot reclaim his £400 of input VAT.
Under standard VAT he would pay £6,000 output VAT minus £400 input VAT = £5,600.
In this case the Flat Rate Scheme saves Daniel £380 for the quarter and removes the need to track every input VAT claim. You can compare the two approaches for your own turnover with the VAT calculator. But the picture flips for a business with heavy input VAT: a retailer buying lots of VATable stock would lose far more by giving up input VAT claims than it gains from the flat rate.
The scheme rewards businesses with high margins and low VATable costs, typically consultants, designers, writers and other service providers who sell their time rather than goods. With few purchases to reclaim VAT on, they pocket the gap between the 20% they charge and their lower flat rate.
It punishes businesses with significant input VAT. The 16.5% limited cost trader rate, introduced to close a loophole, applies if your spending on relevant goods is under 2% of turnover or under £1,000 a year. At 16.5% of gross turnover, a business charging 20% keeps almost nothing, so for many service businesses the limited cost trader rule has removed the advantage entirely.
Whatever scheme you use, you still file a VAT return each period and remain bound by Making Tax Digital for VAT, keeping digital records and filing through compatible software. The Flat Rate Scheme simplifies the calculation, but it does not exempt you from digital record-keeping.
The Flat Rate Scheme is a bet that your input VAT is small. For service businesses it often pays off; for anyone buying lots of stock, it rarely does.
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