What is the Flat Rate scheme?
Instead of paying HMRC the difference between the VAT you charge your customers (output VAT) and the VAT you pay to your suppliers (input VAT), you instead pay a fixed percentage of your VAT inclusive turnover. The Flat Rate percentage is different depending on your business.
Lets look at a couple of examples:
Company A is an IT consultant who has minimal input VAT, and annual turnover of £125,000 excluding VAT. His services are standard rated for VAT, so he charges his clients 20% VAT or £25,000, of which almost all is paid to HMRC. His annual VAT inclusive turnover is £150,000.
As an IT consultant the Flat Rate percentage is 14.5%. Taking 14.5% of the VAT inclusive turnover of £150,000 = £21,750. Unless his input VAT is higher than £25,000 – £21,750 = £3,250, he could benefit from joining the Flate Rate scheme.
Company B manufactures clothing, and pays significant amounts of input VAT on raw materials. Annual turnover is £90,000, and the clothing is standard rates for VAT so B charges 20% VAT on all sales = £18,000. Their annual VAT inclusive turnover is £108,000.
Purchases on which input VAT was payable were £54,000 excluding VAT, with input VAT of £10,800. Net VAT payable to HMRC for the year is therefore £18,000 – £10,800 = £7,200.
As a clothing manufacturer the Flat Rate percentage is 9%. Taking 9% of the VAT inclusive turnover of £108,000 = £9,720. Company B would actually be worse off by £9,720 – £7,200 = £2,520 if they joined the Flat Rate scheme.
Threshold for joining / leaving
You can join the Flat Rate scheme if you are expecting your VAT-able turnover (i.e. turnover excluding VAT, and excluding any VAT exempt sales) for the next year to be £150,000 or less.
Once you have joined the scheme, you can stay in it until your total VAT inclusive business income is more than £230,000. If you want to, you can leave the Flat Rate scheme at any time by telling HMRC.
First year discount
If you are in your first year of VAT registration then your Flat Rate percentage is reduced by 1% until the end of that first year.
Capital assets worth more than £2,000
If you have joined the Flat Rate scheme, you can’t normally claim back any input VAT. However, you may be able to claim back input VAT on capital asset purchases (i.e. a long term asset) with a VAT inclusive price of £2,000 or more.
Do you think you could benefit from joining the Flat Rate scheme? If so, contact your accountant.