Limited companies and the Flat Rate VAT scheme (FRS)

The Flat Rate VAT scheme (FRS) is designed to make it easier for small businesses to fulfil their value-added tax (VAT) obligations.

However, the Flat Rate VAT scheme isn’t necessarily right for everyone: depending on your costs, the standard unsimplified VAT system may be a better option.

And with ‘limited cost trader’ changes in force since early 2017, the previous tax advantages of the FRS have been slashed for some – meaning it’s more likely you’ll need to look into making a change.

What is the Flat Rate VAT scheme?

Under normal circumstances, the amount a business can usually claim back from HMRC)is the difference between what has been charged from the business to its customers and what the firm has paid out in VAT on purchases the company itself has made. This is the standard VAT scheme.

But under the Flat Rate VAT scheme, companies can opt to pay a fixed amount of VAT instead – which, in some circumstances, can save them money.

If they go for this, the business in question is also able to pay the difference between what it has charged its customers and what it pays to the Exchequer, but it will then give up the right to claim VAT on most purchases it makes.

In some circumstances, the VAT claimed on capital assets over £2,000 can still be claimed back – even if your business is a part of the scheme.

Your VAT turnover must be £150,000 or under (not including VAT) to be eligible for the scheme. You’ll need to apply to HMRC to be considered.

How do you work out your flat rate?

The VAT flat rate you use in your calculations usually depends on your business type.

Here are some examples:

• Advertising (11%)
• Computer and IT consultancy or data processing (14.5%)
• Financial services (13.5%)
• Management consultancy (14%)
• Publishing (11%)

You also qualify for a 1% discount in your first year as a VAT-registered business.

Here’s an example of how the flat rate works in practice.

You’re a management consultant and invoice your client for £500 + VAT (standard 20% rate) – a total of £ 600.

Your VAT flat rate (above) is 14%.

This means you pay 14% of £500 to the Exchequer = £70.

Am I eligible for the Flat Rate VAT scheme?

Depending on the type of business you operate, there’s a chance you might not be able to enrol in the Flat Rate VAT scheme.

Provided you’re already a business that is registered for VAT and that your total VAT taxable turnover is likely to be £150,000 or less (without including VAT) in the next year, it’s likely you’ll be able to enrol.

However, there are some circumstances in which you might find yourself unable to join the scheme, so it’s worth preparing in advance for this eventuality.

For example, if you were previously a member of the scheme but left in the last year you’re not entitled to rejoin, while if you’ve committed a VAT-related offence in the last year (such as tax evasion) then you’ll also be banned from enrolling.

Complications could also arise if your business is deeply tied to another business, so check with your accountant or financial advisor if this applies to you.

Joining the scheme also has other conditions, so check in advance before getting your hopes up.

Beware of the “limited cost trader”rules

The Flat Rate VAT scheme has been a real boon for a lot of small companies. But there has also been what the government has described as “aggressive abuse” of the scheme, and for that reason, some changes were made to the system in April 2017.

As a result, all companies who sign up for the scheme must demonstrate whether they are a “limited cost trader” or not.

Limited-cost traders are those who spend under 2%, or less than £1,000, of their VAT-inclusive turnover on goods a year.

For the purposes of this system, HMRC has defined “goods” as anything used exclusively for the business—although capital expenditure, drinks and food for the employees, and transport are all exempt.

The changes are intended to stop a trend of traders making purchases simply to push their costs up above 2% to acquire tax advantages. For a small business, the impact of these changes could be quite large, as they may make you think twice before opting for the Flat Rate system.

So while the FRS system is more simple, it could also be more costly. In order to avoid the higher fixed 16.5% rate, it’s worth asking your accountant to look into the changes and see what your new tax obligation might be.