Choosing the Right VAT Scheme
Selecting between the Flat Rate Scheme and standard VAT accounting can significantly impact your business's cash flow and administrative burden. This comprehensive guide compares both approaches to help you make an informed decision based on your business type, expenses, and growth plans.
1. Understanding Standard VAT Accounting
The traditional method requires:
- Recording VAT on all sales (output tax)
- Claiming back VAT on eligible purchases (input tax)
- Paying HMRC the difference each quarter
- Maintaining detailed records of all VAT transactions
Best suited for businesses with:
- High VAT-able expenses (can reclaim significant input tax)
- Complex transactions requiring detailed tracking
- Mixed supplies with different VAT rates
- Turnover above £150,000 (Flat Rate Scheme limit)
2. Flat Rate Scheme Explained
Simplified approach where you:
- Pay a fixed percentage of your gross turnover to HMRC
- Keep the difference between what you charge customers and pay HMRC
- Generally cannot reclaim input VAT (except for capital assets over £2,000)
- Use sector-specific rates ranging from 4% to 14.5%
First-year businesses get a 1% discount on their sector rate.
3. Key Differences Compared
| Factor | Standard VAT | Flat Rate Scheme |
|---|---|---|
| Record Keeping | Detailed invoices and records | Simplified - just track gross sales |
| VAT Reclaims | Full reclaim on business expenses | No reclaims (except capital assets) |
| Administration | More complex | Simpler |
| Cash Flow Impact | Varies based on expenses | Generally positive for low-expense businesses |
| Eligibility | All VAT-registered businesses | Turnover under £150,000 (excluding VAT) |
4. Calculating Which is Better
To determine which scheme saves you more:
- Calculate your expected annual turnover (excluding VAT)
- Estimate your VAT-able expenses
- Apply your sector's Flat Rate percentage
- Compare with standard VAT liability
Example calculation for an IT consultant with £100,000 turnover and £10,000 expenses:
- Flat Rate (14.5%): £100,000 × 14.5% = £14,500 VAT due
- Standard VAT: £20,000 output VAT - £2,000 input VAT = £18,000 VAT due
- Savings: £3,500 under Flat Rate Scheme
5. When to Switch Schemes
Consider switching if:
- Your business circumstances change significantly
- You approach the £150,000 turnover threshold
- Your expense profile changes (more VAT-able purchases)
- HMRC updates sector rates affecting your profitability
You can leave the Flat Rate Scheme at any VAT return period end by notifying HMRC.