The VAT flat rate scheme (FRS) is a simple way for small businesses to reduce administration and lower their VAT bills.
With standard VAT accounting, the VAT a business pays or claims back from HMRC is the difference between the VAT charged to customers and that paid on purchases.
With FRS however a business:
- Continues to charge its customers VAT at the full rate.
- Pays VAT over to HMRC at a fixed percentage of its turnover (VAT inclusive) – the applicable rate depends on the business type and a list of rates can be found here.
- Keeps the difference between the VAT charged to its customers and what it pays over to HMRC.
- Cannot reclaim VAT on its purchases – except capital assets (such as computer equipment) over £2,000.
A business can join FRS if it is VAT registered and expects its VAT taxable turnover to be less than £150,000 (excluding VAT) in the next 12 months.
Additionally:
- In the first year of registration there is an extra 1% reduction in the fixed rate percentage.
- Capital asset purchases below £2,000, which would otherwise not be eligible for VAT reclaim, may be grouped together if bought from the same supplier at the same time – if the total exceeds £2,000 the VAT may be reclaimed.
A business can stay in the scheme until:
- Its total turnover in the previous 12 months exceeds £230,000 (including VAT).
- It expects its total income in the next 30 days alone to exceed £230,000 (including VAT).
By registering for FRS a business effectively gives up its right to reclaim VAT on purchases so the scheme is generally more relevant to those businesses with a low cost base in relation to turnover.
As a simple example of how FRS works, consider an IT consultant who raises an invoice for £2,000 net but does not incur any costs that contain VAT. For computer and IT consultancy or data processing the fixed percentage is 14.5% – calculated on total income including VAT.
Net invoice £2,000
VAT at 20% £400
Gross invoice £2,400
FRS VAT due to HMRC at 14.5% (£2,400 * 14.5%) £348
Gain from using FRS (£400 – £348) £52
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