What is a limited cost trader on the VAT Flat Rate Scheme?

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The VAT Flat Rate Scheme (FRS) lets small businesses pay a single fixed percentage of their VAT-inclusive turnover to HMRC instead of tracking VAT on every sale and purchase. To stop the scheme being abused by labour-only businesses with almost no costs, HMRC created the 'limited cost trader' category. You are a limited cost trader for a VAT period if your spending on relevant goods is either less than 2% of your VAT-inclusive turnover, or more than 2% but less than GBP 1,000 a year (pro-rated for shorter periods). If so, you must apply the 16.5% rate regardless of your trade sector. Relevant goods are physical items used in the business - they exclude services, capital items, food and drink, fuel for non-transport businesses, and goods bought to give away or resell that are not part of normal trade. The 16.5% rate is deliberately punishing. On GBP 1,000 of work plus 20% VAT (GBP 1,200 gross), 16.5% is GBP 198, leaving you almost no margin versus the GBP 200 of output VAT collected - so most consultants, contractors and service firms with low goods spend are better off on standard VAT accounting, reclaiming input VAT on actual purchases. This mainly affects IT contractors, consultants, and other knowledge-based one-person companies. Check your goods spend each VAT quarter, because the test can flip period to period. The FRS itself remains optional and you can only join if expected VAT-taxable turnover is GBP 150,000 or less (excluding VAT). To compare your VAT position under standard versus flat-rate accounting, use the VAT calculator. The standard VAT rate is 20% and the registration threshold is GBP 90,000 for 2026/27.

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