BIM31585 - Value Added Tax: flat rate schemes

For small businesses

An optional flat rate scheme is available to all small businesses with a VAT exclusive annual taxable turnover of up to £150,000.

This requirement applies at the point of entry into the scheme. Businesses check their turnover on each anniversary of joining the scheme and if it is over £230,000 (VAT inclusive) they must usually leave the scheme.

A business that joins the scheme avoids having to account internally for VAT on all purchases and supplies, and instead calculates its net liability by applying a flat rate percentage to the VAT inclusive turnover. The flat rate percentage depends on the trade sector into which a business falls for the purposes of the scheme. There is a wide spread of applicable percentages ranging from 4% to 14.5%.

Under the flat rate scheme businesses:

  • continue to charge their customers the normal rate for the supply (i.e. not the flat rate percentage) on all taxable supplies of goods or services.
  • issue tax invoices to their VAT registered customers, and also to all other customers if the business chooses to do so (these invoices show the normal rate for the supply and are used for the customers’ VAT reclaim).

They do not have to record all the details of the invoices issued or purchase invoices received to calculate the amount of VAT they must pay to HMRC.

Capital assets

If capital assets are purchased with a VAT inclusive value of £2,000 or more, the VAT can be recovered in the normal way. This concession, however, cannot be used where the assets were:

  • acquired for resale, or for incorporation in goods to be sold
  • acquired to be hired out, leased or let
  • for consumption within one year, or
  • covered by the capital goods scheme.

Further information

Full details of the scheme are included in VAT Notice 733 ‘Flat rate scheme for small businesses’.

Computation of trading profits

The flat rate scheme removes the necessity to calculate VAT on each individual input and output for the VAT account. Instead only the flat rate VAT will need to be passed to the VAT account. Where the concession for capital assets is adopted, the VAT reclaimed will also pass through the VAT account.

Expenses will probably be shown inclusive of VAT as it is irrecoverable (similar to a business not registered for VAT), and it is likely that turnover will be shown net of the flat rate VAT payment. You may however find that the flat rate VAT payment is shown as a profit and loss expense rather than deducted from total turnover.

Where there is irrecoverable VAT on capital items it will form part of the cost of the asset on the balance sheet and of the cost for capital allowances purposes.

Example

A business has gross sales of £84,000 (including output VAT at 20% of £14,000), and expenses of £48,750 (including irrecoverable VAT). The flat rate VAT @ 6% is £5,040. A new machine is purchased (qualifying for capital allowances) at a cost of £2,400 including VAT of £400.

The accounts will show:


Turnover £78,960 (£84,000 less £5,040 flat rate VAT)
Expenses £48,750  
Profit £30,210  

If VAT is not reclaimed on the asset the cost for capital allowances purposes will be £2,400. If VAT is reclaimed the cost will be £2,000.

Service companies (‘IR35’) legislation - deemed payment calculation

The amount to be included under step 1 of the deemed payment calculation is the VAT exclusive amount whether or not the flat rate scheme is adopted. For the intermediary within the flat rate scheme in the example above the VAT exclusive amount would be £78,960. Irrecoverable VAT relating to allowable expenses met by the intermediary would be allowable as part of the expenses in the same way as if the intermediary was not VAT registered. For more information on IR35, see ESM3000 onwards.

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For farmers

There is a special VAT scheme known as the flat rate scheme for farmers which is used by a small number of farmers and horticulturists.

Flat rate farmers are not registered for VAT and consequently they cannot reclaim input tax. They can, however, charge and keep a flat rate addition of 4% when they sell qualifying goods or services to VAT registered customers. This addition is not VAT but acts as compensation for losing input tax on purchases. The flat rate addition is part of the business takings and should be included in sales.

Further information is available from the Business Information Unit (TIP99).