Are you missing out on Flat Rate VAT savings?
It may sound simple, but the flat-rate scheme for VAT continues to cause problems for businesses. This post sets out the basic rules behind the scheme, and highlights some of the potential pitfalls.
Under the flat rate scheme (FRS), you pay VAT as a fixed percentage of your VAT-inclusive turnover. The actual percentage you use depends on your type of business.
The VAT flat rate scheme can work quite well for businesses on low FRS rates and few purchases.
FRS dos and don'ts
- Join the FRS if you have lower than average VAT-rated costs, but not if you make a lot of zero-rated or exempt sales.
- Assess the pros and cons carefully (get an accountant to help you) before joining the FRS and classify your business correctly at the outset.
- Remember the flat rate is applied to sales + standard VAT rate (ie gross), so you charge customers the standard VAT rate and apply the flate rate to gross sales at the end of the quarter.
- Issue and retain VAT invoices to VAT-registered customers.
- Maintain adequate records - this means a VAT account and records of the flat rate percentage applied.
- Do not apply FRS to capital disposals: VAT should be calculated under the full VAT regime.
- Don’t apply the FRS to high-value supplies caught by the anti-carousel fraud reverse charge; these should be accounted for under the full VAT regime.
- Don’t try to backdate your registration retrospectively, you can only go back to the beginning of the current tax period.
- Attempt to use it to avoid outstanding or undeclared VAT liabilities.
The scheme was designed to reduce the administrative burdens for small businesses rather than to give them a tax break, but it can be expensive if you don’t get your initial assessment right. You can opt out of the scheme if it’s not working for you, but HMRC won’t allow to go back and use FRS for period that VAT has already been calculated
How the VAT flat rate scheme works
You can join the scheme to pay VAT as a flat rate percentage of your turnover if your estimated “VAT taxable turnover” - excluding VAT - in the next year will be £150,000 or less.
Your VAT taxable turnover is everything that you sell during the year that is liable for VAT. It includes standard, reduced rate or zero rate sales or other supplies. The scheme excludes the actual VAT that you charge, VAT exempt sales and sales of any capital assets.
Generally you don't reclaim any of the VAT that you pay on purchases, although you may be able to claim back the VAT on capital assets worth more than £2,000.
Once you join the scheme you can stay in it until your total business income is more than £230,000.
Who can't join the Flat Rate Scheme
You can't join the Flat Rate Scheme if:
- You were in the scheme and left during the previous 12 months
- You are, or have been within the previous 24 months
- You are eligible to join an existing VAT group
- You are registered for VAT as a division of a larger business
- You use one of the margin schemes for second-hand goods, art, antiques and collectibles, the Tour Operators' Margin Scheme, or the Capital Goods Scheme
- You have been convicted of a VAT offence or charged a penalty for VAT evasion in the last year
- Your business is closely associated with another business.
Working out your flat rate percentage and the VAT you need to pay
The VAT rate depends on what business sector you work in. There are a range of percentages for different business sectors – for example, accountancy and book-keeping (14.5%), advertising (11%), general building or construction services (9.5%) and hotel/accommodation (10.5%). HMRC has some useful guidance.
You must choose the sector that best describes your main business activity for the coming year. You must only use one percentage. So if you work in more than one business sector, you must use the one that represents the greater part of your turnover. You then apply that percentage to your total turnover.
With 55 categories to pick from, it’s often a case of finding the “nearest best fit”. If there’s no exact match, most end up going into the 12% rate for “other business services.
HMRC and the tribunals will allow companies to rectify genuine errors, but take a dim view of companies trying to opt for more advantageous categories at a later date.
Potential benefits of using the Flat Rate Scheme
- You don't have to record the VAT that you charge on every sale and purchase, as you do with standard VAT accounting. This can mean you spending less time on the books, and more time on your business. You do need to show VAT separately on your invoices, just as you do for normal VAT accounting.
- A first year discount. If you are in your first year of VAT registration you get a one per cent reduction in your flat rate percentage until the day before the first anniversary you became VAT-registered.
- Fewer rules to follow. You no longer have to work out what VAT on purchases you can and can't reclaim.
- Peace of mind. With less chance of mistakes, you have fewer worries about getting your VAT right.
- Certainty. You always know what percentage of your takings you will have to pay to HMRC.
Potential disadvantages of using the flat rate scheme
The flat-rate percentages are calculated in a way that takes into account zero-rated and exempt sales. They also contain an allowance for the VAT you spend on your purchases. So the VAT flat rate scheme might not be right for your business if:
- You buy mostly standard-rated items, as you cannot generally reclaim any VAT on your purchases.
- You regularly receive a VAT repayment under standard VAT accounting.
- You make a lot of zero-rated or exempt sales.
So, is it worth registering with the scheme?
It depends on factors including the industry you’re in and how many of your customers are VAT registers. There is around a 50% probability the scheme will be worth joining. Tax savings from the scheme can be in the thousands of pounds. But get your sums wrong and you could end up paying thousands of pounds more VAT than necessary.
This is why you need expert like Cloud Accounting LLP to perform an analysis of the history and forecast of your sales and expenditure – get in touch with us for a free chat.