VAT Flat Rate Scheme: how it works and when it pays

The short answer: on the VAT Flat Rate Scheme you still charge customers 20% VAT, but you pay HMRC a fixed percentage of your VAT-inclusive turnover, set for your type of business, and keep the difference. You can join if taxable turnover is £150,000 or less excluding VAT, and must leave above £230,000 including VAT. Businesses that spend little on goods must use 16.5%, which removes most of the benefit.

How it works

A consultant invoices £100,000 plus VAT in a year, so receives £120,000. They spend £5,000 plus £1,000 VAT on costs.

The flat rate is applied to the gross figure of £120,000, not £100,000. Any saving counts as business income, so it is taxed too.

Example flat rates

HMRC publishes the full list of sectors. Pick the one that best describes your main activity; if in doubt, ask HMRC and keep a note.

The limited cost trader test

Each VAT period, check how much you spent on goods (including VAT). You are a limited cost trader if that is:

• less than 2% of your VAT-inclusive turnover, or
• more than 2% but less than £1,000 a year (£250 a quarter).

Services, capital items, food and drink for you or your staff, vehicles and fuel (unless you are in transport) don't count as goods. That is why most consultants and freelancers who mainly sell their time end up at 16.5%. At 16.5% of gross, you hand over 19.8% of your net turnover, almost all the VAT you charge.

When it suits a business

• Low VAT-bearing costs but enough spending on goods to avoid the limited cost test.
• Sectors with low flat rates compared with the VAT they would actually pay.
• You value simpler records: no need to track VAT on every purchase.
• First year of registration, when the 1% discount applies.

It suits less well if you make zero-rated or exempt sales (the flat rate applies to them too), buy lots of standard-rated supplies, or are a limited cost trader.

Joining and leaving

• Apply online or by post, at the same time as registering for VAT or later.
• You can leave at any time, but can't rejoin for 12 months.
• You must leave if turnover in the last 12 months was over £230,000 including VAT, or you expect it to be in the next 30 days.
• You can't combine it with the Cash Accounting or Annual Accounting rules in the usual way; the flat rate has its own cash-based option.

Related reading

See when to register for VAT and how to remove VAT from a price. For tax on the profits themselves, see sole trader vs limited company.

First-year discount example

A photographer registers for VAT and joins the scheme straight away. The normal rate for photography is 11%, so for the first year they use 10%. On £60,000 of VAT-inclusive turnover, they pay HMRC £6,000 instead of £6,600. From the first anniversary of VAT registration, the full 11% applies.

Capital purchases

On the scheme you can still reclaim VAT on a single purchase of capital goods costing £2,000 or more including VAT, such as a camera, van or computer system. Claim it in your normal VAT return. If you later sell the item, you must account for VAT on the sale at the normal rate.

Records you still need

The scheme is simpler, not record-free. You still issue VAT invoices showing 20% VAT to VAT-registered customers, keep a record of your flat rate turnover and the percentage used each period, and file VAT returns through Making Tax Digital software. Keep purchase records too, both for the limited cost trader test and for any capital items you reclaim.

Example rates are from HMRC's published list. Check the current rate for your sector on GOV.UK. This is general information, not tax advice.