How does the flat rate VAT scheme work?
There are numerous different VAT schemes available to companies, depending on financial profile. In order to simplify the accounting process, the flat rate VAT scheme was created. This allows business owners to pay VAT on a percentage of turnover , as opposed to individual transactions.
Under this simplified scheme, you charge your customers 20% VAT (the current rate) on all invoices. You pay HMRC a fixed rate of your company’s turnover on a quarterly basis, but you cannot reclaim any VAT on purchases as this is included in the 20% VAT you charge your customers.
Keep in mind that the percentage paid is dependent on the industry that you are in, and varies in accordance to the standard input and output VAT paid by business within each industry. To give an example, professional services, including accountants and contractors, pay a flat rate of 14.5%.
The basics of the flat rate VAT scheme
If your expected turnover is below £150,000 over the next 12 months, your business is eligible to join the flat rate VAT scheme. Your business can remain in the scheme, as long as turnover remains below £230,000.
As stated, your business can’t reclaim the cost of purchases. However, a one-off purchase of £2,000+ (inclusive of VAT) is permitted (there are restrictions to be aware of). This does not have to be an individual item, however use is limited solely for your business (not for resale).
An additional bonus – during your first year of joining the flat rate scheme, the percentage that you apply is reduced by 1%. There are no changes to your invoicing – you just add the standard VAT rate, with the flat rate calculation applying only to your accounts.
Advantages and disadvantages of the scheme
The major benefit of the flat rate scheme is the simplicity. Rather than recording VAT on every transaction, you only need to apply the percentage to your quarterly / annual turnover, in order to calculate your VAT liability.
If your company makes a lot of purchases, or many of your company’s sales are exempt from VAT, then it is more likely that you will be better off remaining on the standard VAT scheme. Of course, it is always best to speak to your accountant regarding this matter – they can work out the potential liability under each scheme, before you make a decision on which way to go.