Value Added Tax and the Flat Rate Scheme

Businesses with taxable turnover (excluding VAT) below £150,000 could greatly simplify their VAT administration and accounting by basing their VAT payments on their VAT-inclusive turnover rather than the normal method using individual sale and purchase transactions. 

The VAT payable to HM Revenue & Customs is based on a flat rate percentage ranging between 4% and 14.5% depending upon the business sector that best matches the main business activity. For example, whereas most food retailers would use 4%, hairdressing businesses are required to use 13%. A full list of the current percentage rates is available on the HM Revenue & Customs website at the following link: http://www.hmrc.gov.uk/vat/start/schemes/flat-rate.htm#5

A newly VAT registered business is allowed to reduce their relevant flat rate by 1% for their first year of registration.

Calculation of turnover

In computing the amount of turnover to be used in the simplified calculation of VAT it should be noted that as well as including all standard rate sales (VAT inclusive amount) plus zero rate sales, a trader must also include any exempt supplies such as rental income and sales to other EU countries.

Treatment of purchases

Input tax charged to the business on revenue and capital purchases is basically ignored except for certain capital equipment where the VAT inclusive cost exceeds £2,000. The input VAT on such items needs to be reclaimed by including a separate entry on the VAT Return.

Flat Rate Scheme Illustration

Sue Smith has been running a VAT registered business for several years as a retailer of ladies and children’s clothing. Her details for the last 12 months of trading are:

Standard rate sales £100,000 (excluding VAT output tax of £20,000)

Zero rate sales £15,000 (children’ clothing)

Standard rate expenses £42,000 (excluding VAT input tax of £8,400)

Assume the flat rate applicable to her business to be £7.5%

Under normal VAT accounting Sue would have accounted for VAT of £11,600 (£20,000 output tax less £8,400 input tax).

Under the Flat Rate Scheme her VAT payable would have been £10,125 (£120,000 + £15,000 = £135,000 x 7.5%) resulting in an overall saving of £1,475 compared to normal VAT accounting.

Possible advantages of using the scheme

  • VAT does not need to be recorded on every individual sale and purchase.
  • There may be a reduction in the overall amount of VAT payable.
  • Completion of the VAT return is made much easier, with less chance of making errors.

Possible disadvantages of using the scheme

  • Apart from certain capital purchases, input tax is not recoverable
  • Traders with VAT-registered customers must continue to issue VAT invoices showing VAT calculated in the normal way.
  • There may be an increase in the overall amount of VAT payable due to the inclusion of zero-rated and exempt supplies.

Note that the Flat Rate Scheme is not suitable for every small business and a registered trader must leave the scheme once their VAT-inclusive annual turnover exceeds £230,000.

Full details of the Flat Rate Scheme and other schemes available to small and medium sized businesses, such as the Annual Accounting Scheme and the Cash Accounting Scheme, can be found at: http://www.hmrc.gov.uk/vat/start/schemes/index.htm

If you require any further information or advice regarding the Flat Rate Scheme or the other VAT schemes mentioned above then please call us on 01633 215544 or email us at contact@marshvision.com