How does the VAT flat rate scheme percentage work?

Full answer

The VAT Flat Rate Scheme (FRS) simplifies VAT accounting for small businesses with annual taxable turnover of GBP150,000 or less (excluding VAT). Instead of tracking and reclaiming input VAT on every purchase, you pay HMRC a fixed percentage of your gross (VAT-inclusive) turnover. The flat rate percentage is set by business sector. You still charge customers 20% VAT on sales (as normal) and issue standard VAT invoices. But when you pay HMRC, you apply your sector flat rate to your gross turnover (including the VAT you charged). The difference between what you collected from customers and what you pay HMRC is yours to keep -- this is effectively a VAT margin retained. Example: a computer consultant (flat rate 9.5%) raises a GBP10,000 invoice + GBP2,000 VAT = GBP12,000 gross. They pay HMRC 9.5% of GBP12,000 = GBP1,140. They keep GBP2,000 minus GBP1,140 = GBP860 profit on the VAT. In the first year of VAT registration, a 1% discount applies -- so the consultant would pay 8.5% in year one. The limited cost trader rate: if your spending on goods (not services, not capital assets) is either less than 2% of your gross turnover OR less than GBP1,000 per year, you are a "limited cost trader" and must use a flat rate of 16.5% instead of your sector rate. This catches businesses that have very low material costs, such as most service businesses, and removes much of the FRS benefit. When FRS helps: if your actual input VAT (on purchases) is less than the margin you retain under FRS. When FRS hurts: if you have high VAT-able costs (materials, equipment), actual VAT accounting may be cheaper. You cannot reclaim input VAT on purchases under the FRS (except on capital goods costing over GBP2,000 including VAT). You leave the FRS if your turnover exceeds GBP230,000 (gross) per year.

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