Update – The VAT Flat Rate Scheme from 1 April 2017
The FRS used to be really profitable for Contractors. However since new rules were announced with effect from 1 April 2017 this is no longer the case. As such we the advice on this page is no longer relevant. Instead we recommend using our new calculator which you can find here which will tell you which scheme is best for you.
In this post we explain the VAT Flat Rate Scheme, provide a calculator to work out if you would be better off on it and then talk about the 1% year one discount and £2,000 capital purchase allowance.
How the Flat Rate Scheme works
Under the standard VAT scheme you add VAT onto your sales and set aside that money to give to HMRC. Then when you buy something you can claim back the VAT included on your purchases from HMRC.
So if you take the example of an IT Contractor who bills their client £5,000 + VAT per month but also has £100 + VAT of expenses.
That would look like this:
Owed to HMRC
Under the Flat Rate Scheme (“FRS”) you completely ignore the purchase side of the equation and instead pay a reduced amount of the VAT on your sales to HMRC. You still charge your clients 20% though and get to keep the difference between what you charge your client and what you pay over to HMRC.
An IT Contractor uses the discounted rate of 14.5%. So following the same example above, the VAT calculation would be simply:
£6,000 x 14.5% = £870 due to HMRC.
Note that we used £6,000 as our sales number, the amount we charged our client including VAT.
So under the Flat Rate Scheme our IT Contractor saves £110 per month, or £1,320 per year just by choosing a more efficient VAT scheme.
VAT Flat Rate Scheme Calculator
Find out if you would save money under the VAT Flat Rate Scheme.
Enter your monthly sales and purchases (but just the ones that have VAT on them) excluding VAT then pick your profession to see an estimate of whether you would be better or worse off on the VAT Flat Rate Scheme. If you have a recent VAT return enter Box 6 for the Sales and Box 7 for the Purchases.
Who the FRS is not suitable for
Whilst the IT Contractor in the example above benefited nicely from the VAT Flat Rate Scheme, if the Contractor had more expenses it might not have worked out so well.
Let’s say the Contractor rents an office. So instead of just £100 + VAT per month they actually have expenses of £1,000 + VAT per month. Under the normal VAT scheme they would owe £800 of VAT for the month but under the FRS they would still owe £870 as the higher costs are ignored.
So where a Contractor or a business has a high proportion of expenses the Flat Rate Scheme can result in losses. Since most Small Businesses break-even or make a loss in their first year it’s often best for them to stay on the standard scheme.
In reality most Contractors tend to have few expenses apart from food and travel (which rarely includes VAT on it anyway) so the Flat Rate Scheme usually turns out very favourable.
Different FRS Rates for different occupations
Different occupations use different FRS rates. Our IT Contractor example above had an FRS Rate of 14.5% but the rates actually vary between 4% for retailers and 14.5% for IT Consultants and Accountants. Here are the most common rates:
Current FRS Rate
|Architect or engineer||14.5%|
|Computer and IT consultancy||14.5%|
|Estate agency or property management||12%|
You can see the full list here.
1% Discount in Year 1
If you are in the first year of your VAT registration and on the VAT Flat Rate Scheme you are able to claim an additional 1% reduction in your FRS Rate.
So sticking with our IT Contractor example, we said that sales of £5,000 + VAT at a rate of 14.5% resulted in VAT owed of £870. In fact if it is less than one year since registering for VAT then the rate that would be applied is 13.5% so that actually means £810 of VAT owed. A further £60 saving per month or £720 for a full 12 months!
The key date for the FRS discount is your original VAT registration date. So if your company registered for VAT on 06/08/2015 you would be able to keep claiming the lower FRS rate until 05/08/2016. If you originally registered for VAT a few years ago and are only now moving over to the FRS you will not get the discount.
Capital purchases of more than £2,000
Throughout this post we have said that under the VAT Flat Rate Scheme you cannot claim back the VAT on your purchases. That’s not exactly true.
If you make a single purchase for a capital item (meaning an asset that will last a few years) and spend more than £2,000 including VAT you CAN claim the VAT back.
So let’s say our £5,000 + VAT per month IT Contractor buys a server for £3,000 + VAT. They would still work out the VAT on sales as £6,000 * 14.5% = £870 but would be able to deduct the actual VAT paid on the server (which is £600). So:
(£6,000 * 14.5%) – (£3,000 * 0.2) = £270
It’s really important that you have a single VAT receipt that exceeds £2,000. If you were to buy various parts from different suppliers that add up to £2,000 that wouldn’t be allowable.