Ainsworth Accountants: Accounts, Tax and Business Advisors.

VAT: Flat Rate Scheme (FRS)

In April 2017, there is a major change to the Flat Rate Scheme (FRS) affecting low "cost" businesses.

From 1 April 2017, HMRC will introduce a new category, of a "limited cost trader", with a flat rate of 16.5%. So for a business on 16.5%, for every £1 of VAT it charges its customers, 99p will be paid to HMRC.

Consequently many businesses, above the registration threshold (2016/17: £83,000), will move to the standard VAT scheme and will reclaim VAT on costs. Those below the registration threshold are likely to deregister.

A business is a "limited cost trader" if its VAT inclusive expenditure on goods is:
• Less than 2% of its VAT inclusive turnover in a VAT period, or
• Greater than 2% of its VAT inclusive turnover but less than £1,000 per annum (£250 per quarter).

Goods are those used exclusively for business purposes, and exclude capital expenditure and food & drink.

It is not yet clear whether costs usually described as "services", rather than "goods", eg. telephone, software, insurance, bank charges and accounting fees will count as "goods".

We will have more details in the March 2017 Budget.

What is the VAT Flat Rate Scheme?

VAT Flat Rate Scheme Guide

The VAT Flat Rate Scheme is simple to run and can be financially advantageous.

Most VAT Registered "Small Businesses" can choose to be in the VAT Flat Rate Scheme.

You can choose the Flat Rate Scheme from initial VAT Registration, or you can switch to it at any time.

This webpage assumes that you know the basics of the standard VAT scheme, details available on our VAT Webpage Guide.

Please ensure that you understand the FRS and your eligibility by referring to the HMRC Flat Rate Scheme Guide and HMRC Notice 733.

Eligibility for the Flat Rate Scheme

The Flat Rate Scheme is for small businesses. You can apply to use the FRS if you estimate that your taxable turnover (excluding VAT) in the next year will be £150,000 or less.

Once you join the FRS scheme you can stay in it until your total taxable turnover (excluding VAT) is more than £230,000.

Flat Rate Scheme Basics

You pay over to HMRC a VAT amount calculated on your gross sales (ie. sales + 20% VAT) multiplied by the FRS Rate for your type of business.

You cannot claim any VAT back on purchases/expenses, apart from on some capital purchases.

You must continue to charge your customers VAT at your normal rate, eg. standard rate at 20%, and raise your invoices as normal - there is no difference here between the FRS and the standard VAT scheme.

The Special Calculation of Output Tax

  A:  Add up your total gross sales, ie. including VAT charged.

  B:  Find the appropriate FRS Rate for your type of business.

  C:  Output Tax payable = A x B.

  D:  Do not reclaim any Input Tax (apart from on some capital expenditure).

  E:  For the first year of VAT registration you may apply a 1% deduction
       to your FRS Rate.

The normal basis for FRS is the accruals basis. However the FRS has it own Cash Based Method which for most businesses is exactly the same as the Cash Basis for the normal VAT Scheme.

Backdating VAT Flat Rate Scheme Registration

If you are registering for VAT and FRS at the same time, your VAT/FRS registration can often be backdated to the point when you request your VAT registration to commence. Surprisingly this can even be up to a year ago.

If your business is already VAT registered, and you want to switch to FRS, you would normally change from the start of the last unfiled VAT Return. If you have been VAT registered for more than one year, when you switch to FRS, you will not be entitled to the 1% first year discount.

More VAT Information

These links will take you to more information on the HMRC website:

VAT Invoice
When to register
Introduction to VAT
HMRC Flat Rate Scheme Guide
HMRC Notice 733.

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Comparison of
Standard VAT Accounting Scheme
and VAT Flat Rate Scheme

Standard VAT Accounting Scheme

Year Trading Summary Net VAT Gross
Sales £50,000 £10,000 £60,000
VAT Expenses   £2,000      £400   £2,400
Non-VAT Expenses £15,000          £0 £15,000
Net Profit £33,000
In the above Standard VAT Accounting Scheme example, the turnover is below the VAT Registration Threshold, but the business could still register voluntarily.

The company would pass on to HMRC, the £10,000 VAT charged to customers, and would also be able to reclaim the £400 VAT incurred on Expenses. Net VAT payable to HMRC over the year is £9,600.

VAT Flat Rate Scheme

If the same business instead elected for the Flat Rate Scheme, it would not be able to reclaim the £400 incurred on Expenses.

However, if for example its FRS Percentage was 14%, the business would pass on to HMRC 14% of the Gross Sales of £60,000, ie. £8,400, and still collect the £10,000 from their customers, with an FRS gain of £1,600 on Sales.

After losing the £400 VAT claim on Expenses, the net FRS gain is £1,200.

This FRS gain would be added to the Net Profit and therefore would be subject to Corporation Tax.

In this example, if the Corporation Tax rate is 20%, the Corporation Tax on the FRS gain (only) is £240. Therefore the overall annual gain of using the Flat Rate Scheme, after tax, is £960.