As a business, working out your finances is likely to be one of the more complex and time-consuming duties you need to perform. Further still, working out your VAT is considered to be one of the more error prone and challenging tasks within this broader accounting responsibility, so it is hardly surprising that getting their VAT in order can be something that many business owners dread.
The Flat Rate VAT scheme is designed to make this process simpler for those who are eligible, helping you to get your VAT done quickly and simply, without burdening you with a lot of extra work.
What Is VAT?
VAT stands for Value Added Tax and is a tax that you charge on the goods and services that you supply. You pay this tax over to the government (specifically to HMRC) usually every quarter, after you have deducted the VAT charged on the products and services that your business has purchased in the same time period.
VAT applies to the vast majority of transactions performed in the UK, albeit with a large number of important exemptions (or reduced rates of VAT) some of which are:
- Education and training
- Finance and credit
The Flat Rate VAT Scheme
The Flat Rate VAT scheme essentially simplifies the VAT process to cut it down to one easy step. Those who are registered with the scheme just pay a fixed amount of VAT to HMRC and keep the difference between what they pay and what they charge their customers.
Businesses working under the Flat Rate VAT scheme are not able to claim back the VAT on their purchases, except for on certain capital assets over £2,000.
To be eligible for the scheme, businesses must have an annual turnover of less than £150,000 excluding VAT. If you estimate that your business turnover excluding VAT will exceed £150,000 in your first year then you shouldn’t join the scheme.
You must also leave the scheme when your annual turnover exceeds £230,000, or risk a penalty if you fail to do so.
Companies are able to claim back VAT on certain capital asset purchases if they exceed £2,000. A PC worth £2,000 would qualify as would a PC and printer worth £1,500 and £500 respectively if they are on the same receipt. However, you cannot add items together from separate receipts so that they make more than £2,000 and then claim this back.
Businesses under the Flat Rate scheme are required to complete a quarterly VAT return in the same way as all other businesses. When applying VAT to your invoices, you would usually charge the standard VAT rate (currently 20%) to each. On the Flat Rate scheme, instead of accounting for the VAT on every payment, you will only pay one single flat rate payment as a percentage of your turnover each quarter.
One of the most appealing things about the Flat Rate VAT scheme for smaller businesses is that the VAT percentage you need to pay is much lower than the standard VAT rate, meaning that you can keep the difference as profit, improving your cash flow and making managing and reporting on the tax that bit less stressful.
What Flat Rate Would You Pay?
Different types of businesses are required to pay different Flat Rates under the scheme. The HMRC website has an exhaustive list of these rates that you can look at, but here are some examples of the types of rates there are:
- Catering services pay 12.5%
- Hairdressing and beauty services pay 13%
- Computer repair services pay 10.5%
- Management consultants pay 14%
- Hotels and accommodation pay 10.5%.
On top of this, you also get a 1% discount on your Flat Rate in your first year as a Flat Rate VAT-registered company.
The Limited Cost Trader Flat Rate VAT Scheme
The Flat Rate VAT scheme has been a big hit with smaller businesses, helping many to deal with cash flow issues in their early days and get to grips with the tax system. However, HMRC did report that there appeared to be some abuse of the VAT Flat Rate scheme occurring, and in April 2017 implemented new legislation in order to tackle these issues.
A steadily increasing number of sole traders, growing at an unexpected rate since the inception of the scheme, was cited by the Treasury as the cause for decreasing tax revenues. As a result, HMRC brought in the limited cost trader test, which means that now many small businesses pay a flat rate of 16.5% VAT.
What Is A Limited Cost Trader?
A limited cost trader is defined as a business whose gross expenditure on qualifying items is:
- Less than 2% of their annual turnover or
- More than 2% of the annual turnover but still less than £1,000 per year
When working out your gross expenditure on “Qualifying items”, you need to add up the VAT inclusive prices of everything you have bought in connection with the business, but exclude invoices that reflect spending on the following:
- Food and drink expenses
- Capital expenditure
- Vehicles and fuel
HMRC has a higher rate calculator on their website to help you to work out whether or not your fit into the limited cost trader category if you are still unsure.
Should You Apply For The Scheme?
For smaller businesses, there are many benefits to using the Flat Rate VAT scheme, such as:
- Although you need to show VAT separately on your invoices as with normal VAT accounting, the Flat Rate scheme offers you a much faster and simpler form of VAT accounting in that you don’t have to record the VAT that you charge on every single sale or purchase.
- There are fewer rules to follow that with standard VAT, which in the early days of business can be critical to a new business owner who is still getting to grips with accounting and tax matters.
- Fewer rules also means fewer mistakes, and less chance of facing a penalty as the result of filing something incorrectly.
- Finally there is an element of certainty to working under the Flat Rate scheme, so that you know how much of your earnings you are expected to pay to HMRC at the end of your accounting period, allowing you to budget for it and make sure that the money is there and ready to be paid by the deadline.
VAT is certainly one of the most challenging taxes businesses in the UK have to face. With the standard system of VAT that has been in use for decades, business owners have had to be certain they charge the correct rate of VAT on their products and services, and also have to account for every single penny in VAT that they have charged or been charged.
This is not as much of a tall order as it used to be, and there is no doubt modern accounting systems have helped greatly in managing the complexity of administering VAT, but there are still many traps for the unwary and if you make a mistake – it’s on you, you cannot blame the computer!
Why not speak to the experts at TFMC about how we can take away all the hassles of VAT, and design you a system that works for you and your business, all with the added reassurance of having one of our experts available to help and advise you if you need it.
Whether you operate a flat rate scheme or a standard one, we are here to help. Please contact us on 0800 470 4820 or email firstname.lastname@example.org to find out more.