The VAT flat rate scheme was introduced by the UK government to make it easier for small businesses to arrange their VAT payments. The scheme means that the VAT a business owes to HMRC is calculated as a percentage of turnover. Many businesses feel that the scheme has simplified their calculations and ensured that they don’t make any potentially costly tax errors, but is the scheme right for your business?
In this article, we will explain the potential benefits of the VAT flat rate scheme, how it is calculated and which industries it is most suited to.
What are the potential benefits of the VAT flat rate scheme?
The biggest potential benefit of the scheme claim is that it can save businesses a lot of time and hassle. This is because businesses do not have to calculate separate VAT on every single sale and purchase. The scheme also makes filling out tax returns, managing cash flow and assessing finances much easier meaning that many small businesses who previously needed to pay an accountant can now do these things themselves. Another potential benefit is that paying VAT as a percentage of your overall turnover could save you money compared to paying the tax on every transaction.
How can you check if your business is eligible for the scheme?
Any business can take part in the scheme as long as their forecasted annual turnover for that year is no more than £150,000. To check whether you are eligible, you can check your VAT returns for previous years to calculate your annual turnover. If it is a business that you have just started you can use your business plan, recent profits or business loan details to forecast your annual turnover. Alternatively, if it is a business you have just taken ownership of, you can use the previous year’s turnover to join the scheme.
However you make the calculations, as long as you are able to show how you came to the final number, there are no penalties if your forecasted turnover is more than you forecast. If HMRC suspects that you have deliberately tried to deceive them then you will not be allowed to join the scheme which is why it is so important that you keep records of how you calculated your turnover. If your turnover increases while your business is part of the scheme, you will be allowed to remain in it as long as it does not increase to more than £230,000.
Which other factors can affect eligibility?
As well as maximum turnover there are various other factors that could make your business ineligible for the scheme. These include:
- Your business taking part in the Capital Goods Scheme for any goods
- Your business not being currently registered for VAT
- Your business currently or within the previous two years being a member of a VAT Group
- Your business having left the scheme within the previous twelve-month and now reapplying
- Your business being part of the second-hand margin scheme
- You receiving a fine or conviction for VAT offences or another offence involving deception or dishonesty in the previous year
- Your business being part of the auctioneer’s scheme
- Your business is structurally or financially tied to another business
- Your business is directed or controlled by another business
How can you apply for the scheme?
You can apply to participate in the VAT flat rate scheme when you register your business for VAT. To do this you will need:
- Your business’s VAT registration number
- Your business’s flat rate VAT percentage based on its sector
- Your forecasted turnover
Can your business claim back input tax when participating in the VAT flat rate scheme?
Input tax is VAT added to a business’s bill by another business when they have hired them to provide a service. Usually, this tax can be claimed back, but if you join the VAT flat rate scheme, this money will be accounted for within your flat VAT rate so you cannot claim it back separately.
Which other schemes are/aren’t compatible with the VAT flat rate scheme?
As noted above, one of the main benefits of the VAT flat rate scheme is that it can save your business a lot of time and money. For this reason, it works well with Annual Accounting and many businesses have found the two together have been very beneficial.
However, there are various other schemes that do not work well with the VAT flat rate scheme because it already has similar provisions. These include Cash Accounting and a number of different retail schemes, so if you use any of these currently, you need to consider what type of business you are running and whether making a switch to flat rate VAT will actually benefit you.
How much is flat rate VAT?
The percentage of turnover which your business will have to pay depends on which sector you are operating in. Each sector has a different percentage so you will need to check with HMRC about which sector your business is categorised as. For example, the majority of businesses in the building industry have a 9.5% flat rate VAT. These include tradespeople like plasterers, plumbers and carpenters, earthmoving companies, extension builders, roofing companies and glazers. It is important to note that you will receive a 1% VAT discount the first year you participate in the scheme as a welcome gift so you will need to take that into account when deciding whether the scheme is worth it.
If the nature of your business changes and you start to make more money from a different sector then the percentage you will need to pay may also change. This will come into effect the following year.
What is/isn’t included in your turnover for flat rate VAT payments?
To calculate how much flat rate VAT your business is liable to pay, you first need to know exactly what needs to be included in your calculations. This will help you to factor these things into your annual turnover forecasts so that you don’t end up overpaying or underpaying by mistake.
Some of the things which must be included are:
- The supplies produced by your company
- All of your business’s capital expenditure goods
- All income from zero-rate, reduced-rate and standard-rate supply goods
Some of the things which you don’t need to include are:
- Private sales goods
- Bank interest
- Sales of capital expenditure goods (on which you have claimed input tax)
- Income from private sources like shares
- Outside income
There may be additional required inclusion or exclusions depending on the regulations that govern your particular industry so make sure you research these thoroughly to make sure your turnover and flat rate VAT calculations are correct.
How to calculate your business’s turnover for the VAT flat rate scheme
There are three ways to calculate your turnover under the scheme: basic turnover, retailer’s turnover and cash-based turnover. The best way for you will depend on the structure and industry of your business.
1. Basic Turnover
This is the easiest way to transition to the VAT flat rate scheme if you have previously been calculating your accounts based on your invoices. It is also the best way to calculator turnover if your business predominantly deals with other businesses that are VAT registered. To calculate basic turnover you just need to take into account all of your business supplies that owe tax during that VAT period and calculate your business’s flat rate VAT percentage.
2. Retailer’s Turnover
Retailer’s turnover works in the same way as a VAT retail scheme. This is the best calculation strategy if your business predominantly profits from selling retail goods to the public. Retailer’s turnover is calculator as a flat rate percentage of your daily profits plus any additional income that your business generates. As noted above, this percentage is dependant on your business’s industry.
3. Cash-Based Turnover
Cash-based turnover works in a similar way to cash accounting. This is often the best option if you have customers whose payments are often delayed or your business model involves giving customers extended credit. Cash-based turnover is calculated on the payment date, not the date you deliver the product or service. The percentage of flat rate VAT you will pay is again dependent on your business’s industry.
What evidence to keep for HMRC
It is vital that you hold onto evidence of exactly how you calculated your flat rate turnover. Some of the information you may need to show to the HMRC includes:
- The flat rate VAT percentage you are using
- Your turnover during the specific tax period in question
- How much VAT your business owes based on the above two numbers
- A copy of your business’s VAT invoices
All of this will help if HMRC question your calculations or accuse you of deliberately or inadvertently paying the wrong VAT amount.
How does the scheme affect capital expenditure?
Participating in the scheme means that your business does not mean that your business will have more opportunities to claim capital expenditure on certain goods. Capital expenditure only covers non-consumable items that you buy for business use. For example, a photocopier is a capital expenditure item but its ink and paper are not because they need regular replacement. However, you can reclaim input tax for these items.
Here are some other things which are not incorporated into the scheme:
- Any items purchased for later resale
- Any items that last less than a year
- Any items purchased for later lease, hire or let
- Services your business has paid for or provided to yourself
For capital expenditure items that are incorporated into the VAT flat rate scheme, you can reclaim VAT on any item or “single purchase” over £2,000.
Single purchase means that you can claim tax back on any individual receipt or order that is over £2,000. For example, if you are buying new furniture for your conference room, and you buy £2,500 worth of furniture from one supplier, you will be able to reclaim the VAT even though none of the individual items cost more than £2,000. However, if you buy the chairs from one supplier, the conference table from another and the monitor from another, and none of the individual receipts is more than £2,000, you will not be able to claim the VAT back.
What is the difference between goods and services?
As noted above, you cannot claim back VAT on any services that your business has paid for or provided to yourself. For example, if you have a building company and you use your own skills, time and materials to build an extension to your company’s office, you cannot reclaim VAT for providing yourself with your own time and services. Other services include things your company uses but does not own such as vehicles you may rent which also are not eligible to claim tax back on.
In the example of building yourself an office extension, you would also be unable to claim the VAT back on the building materials. On the other hand, if you bought an entirely new office to operate from, you could claim the VAT back as this purchase would fall under capital expenditure.
What are considered hire, let or lease goods?
Any item that your business purchases in order to make money does not fall under the category of capital expenditure. For example, if you have a party planning company that rents out disco lights and smoke machines, you cannot claim the VAT back on those purchases.
Deciding if a move to the VAT flat rate scheme is right for your business will require you to accurately calculate your turnover, identify which items are eligible to reclaim VAT on and find out what the flat rate percentage is for your business’s sector. Then you can work out whether making the move will save your business enough time and money to make it worth your while. Remember that if you decide to apply for the scheme, you may need to show HMRC how you came to your final turnover and VAT figures so make sure you keep all your evidence and calculations.