What is the VAT Flat Rate Scheme (FRS)?

The VAT flat rate scheme used to result in a higher recovery rate of VAT for small businesses, but recent amendments to the scheme have reduced the benefits of this scheme to small businesses such as consultants.
HMRC introduced this scheme to make accounting for VAT simpler. You still have to charge VAT on all the work you do for UK businesses but you cannot recover the VAT you have been charged (and therefore you do not have to record the VAT you have incurred on purchases and expenses, which saves a lot of extra analysis). Instead you apply a reduced percentage to your gross sales income and pay this amount to HMRC. There is a list of different business sectors, from which you select the most appropriate to you, and each sector has a set percentage that must be applied to gross sales.

From April 2017 we expect that the majority of our clients are likely to fall within the limited cost trader category for which the rate is 16.5% (15.5% in first year of registration). A limited cost trader is one who spends very little on qualifying goods which, for consultants, is likely to mean stationery, books and certain software (hard format not downloaded). Capital items like laptops are excluded as ‘goods’ and all services such as travel and subsistence are also excluded.

HMRC have provided the following further examples of goods that are specifically excluded:

  • Accountancy fees, these are services
  • Advertising costs, these are services
  • An item leased/hired to your business, this counts as services, as ownership will never transfer to your business
  • Food and drink for you or your staff, these are excluded goods
  • Fuel for a car this is excluded unless operating in the transport sector using your own, or a leased vehicle
  • Laptop or mobile phone for use by the business, this is excluded as it is capital expenditure
  • Anything provided electronically, for example a downloaded magazine, these are services
  • Rent, this is a service
  • Software you download, this is a service
  • Software designed specifically for you (bespoke software), this is a service even if it is not
    supplied electronically

You’re a limited cost trader if the amount you spend on relevant goods including VAT is either:

  • Less than 2% of your VAT flat rate turnover
  • Greater than 2% of your VAT flat rate turnover but less than £1000 per year

If you are not a limited cost trader you can apply and use the appropriate business category rate rather than 16.5%. This assessment should be carried out on a quarterly basis and the appropriate rate applied each quarter.

If your agreed flat rate is 16.5% and you invoice your client for fees of £10,000 (plus £2,000 VAT), the VAT payable to HMRC will be £12,000 x 16.5% = £1,980.00. This means that you retain £20 of VAT.

The scheme is only available to businesses who forecast their taxable net turnover will not exceed £150,000 in the subsequent 12 months. Taxable turnover excludes VAT and supplies of services made to businesses outside the UK. Once you have joined you have to check your level of turnover each year and will usually be required to leave the scheme if this exceeds £230,000 over the past 12 months. For these purposes both VAT and supplies made to businesses outside the UK are included in the turnover calculation.

The flat rate scheme is usually not suitable if you incur a high level of VAT on expenses (perhaps because you use sub-contractors) or if most of your work is for businesses outside the UK. Comprehensive information can be found on the link below to Flat rate VAT notice 733.

Read the government guidance on the Flat Rate Scheme for more information.

Read: VAT Explained

Amy FowlerWhat is the VAT Flat Rate Scheme (FRS)?