Value Added Tax (VAT), a flat-rate scheme, was introduced in order to simplify the VAT accounting for small businesses. This allows them to spend more time running their business and less time with the books.
The VAT flat rate scheme allows businesses to pay between 4-14.5% in VAT, even though they cannot reclaim the VAT they paid on their purchases.
Who can (and cannot) join the flat rate scheme
The flat rate scheme is not mandatory, but there are certain criteria that must be met to join. For example, your estimated taxable revenue in the following year should not exceed £150,000, excluding VAT.
You can stay on the flat-rate scheme until your business’s total income exceeds £230,000. At that point, you will need to contact HMRC.
You cannot participate in the scheme if you:
- You have been convicted for a VAT offense in the past 12 months.
- You have left the scheme before in the past twelve months.
- You are closely related to another business.
- You have the right to join a VAT group if you are eligible (or were in the last two years).
- You can use a margin plan for items such as second-hand goods, art, collectibles and antiques, or you can choose the Tour Operators’ Margin Scheme or Capital Goods Scheme.
The advantages and disadvantages of a flat RFlate rate
The advantages of the flat-rate scheme are greater than the disadvantages for most small businesses, but this is not always the case.
The main benefits of joining the scheme include:
- It is not necessary to record the VAT on each sale or purchase. This allows you to focus on running your business and less on the accounting. However, you will need to separate the VAT on your invoices. (See below for more information on invoicing and records keeping).
- If you’re in your first year as a VAT registered, you can get a 1% discount on your flat rate percentage. You are eligible until the day before your first anniversary.
- Peace of mind is improved. The VAT process is simplified by fewer and simpler rules. This reduces the chances of errors.
- Tax planning has been greatly improved. Tax planning is much easier when you know how much of your income to give to HMRC every year.
The following are some of the potential disadvantages to joining this scheme:
- On standard-rated items, you cannot claim any VAT (see below the section about capital assets).
- The standard VAT accounting rules do not allow you to get a VAT refund.
- You will pay the same flat rate of tax even if your sales are exempt or zero-rated.
Calculate Your Percentage
You will need to calculate the total tax owed once you have joined the scheme by applying a flat-rate percentage to the turnover for the time period. The percentages vary by industry. A complete list of the current rates is available from HMRC.
You can use this rule if you think that your business activities will be spread across several sectors in the next year. Choose the sector you feel best represents your main activity and then apply the percentage to your entire business turnover. This rule is in your favor if you have a secondary business that takes up a large portion of your activities and your main activity is taxed at a lower percentage.
Remember that your flat-rate percentage will be reduced by one percent if this is your first year of registration.
Invoicing and record keeping
You must keep accurate records under the flat-rate VAT scheme. These include your turnover as well as the flat-rate percentage that you used and the amount of tax due.
You must still show the VAT rate on your invoices, regardless of whether you pay HMRC at a flat rate or if it is reduced. When it’s time to submit your VAT under the flat-rate scheme, you will need to fill out a standard form in a slightly unique way. HMRC provides plenty of support.
Handling Capital Assets
The scheme does not allow you to claim the VAT on the capital assets you purchase for your business. This is because the VAT has already been taken into consideration in the flat rate you pay. In certain cases, you can deal with capital goods totaling more than £2,000 (including the VAT) outside the scheme.
HMRC has a complete list of the requirements for capital assets. When you can reclaim VAT on inputs in a standard manner, you must also account for the VAT at the standard rate when you sell the asset.
Leave the Flat Rate Scheme
You can only join the flat-rate scheme if you have an annual taxable income of less than £150,000. However, you can remain in the program until your total business revenue exceeds £230,000. At that point, you will need to contact HMRC.
You can also opt out of the scheme at any time.
Would you benefit from the VAT flat rate scheme?
Contact us to schedule a free, no-obligation consultation to determine if the VAT flat rate scheme will work for you.
