The Flat Rate VAT scheme & the Limited Cost Trader test

VAT is one of the more complex accounting practices you’ll have to undertake as a business, which is why it can help to make it as simple as possible.

The Flat Rate VAT scheme does exactly this and, if you’re eligible, could save you the headache of unnecessary work.

What is VAT?

In short, VAT is the rate you pay (and charge customers) for goods and services. Standing for Value Added Tax, VAT is charged on VAT-rated items.

Those items exempt from VAT include; rent, education and training, insurance, finance and credit and fund raising events by membership organisations. You can see the full list of items exempt from VAT here.

When do I have to register for VAT?

VAT registration becomes compulsory when your VAT taxable turnover is more than £85,000 in a 12 month period (this is the VAT threshold) or if you expect your turnover to exceed this threshold in a single 30 day period.

If your turnover is below the VAT threshold you can still voluntarily register for VAT if it is financially beneficial for your business.

Circumstances where voluntary VAT registration are beneficial include:

To avoid financial penalties

If you’re on the cusp of the VAT threshold, it may benefit you to register beforehand to save any potential penalties.

To boost your business profile

Volunteering for VAT registration may give others the impression your business is more successful, and subsequently help you gain new clients.

To gain a VAT registration number

Displaying a VAT registration number on your business website may give others faith in your business and help you portray a more professional impression.

To ease business transactions

Some suppliers and organisations may refuse to deal with companies that are not VAT registered. Voluntarily registering could open new doors for your business.

The Flat Rate VAT scheme

Usually a business will deduct the VAT charged on what they buy from the VAT charged on what they sell to customers.

The Flat Rate VAT scheme simplifies this process into one step.

Under the Flat Rate Scheme a business pays a fixed amount of VAT to HMRC and you keep the difference between what you pay and what you charge your customers.

With the Flat Rate VAT Scheme you can’t claim back the VAT on your purchases, except for certain capital assets over £2,000.

To be eligible for the Flat Rate VAT Scheme your business must have an annual turnover of £150,000 or less (excluding VAT).

To register Flat Rate VAT Scheme, you must apply to HMRC. We explain how you do this later in this guide.

What’s your flat rate?

The amount of VAT you pay under the Flat Rate scheme will depend on the type of business you own. Some examples of the Flat Rate VAT percentages for different businesses are;

  • Catering services will pay 12.5%
  • Hairdressing or beauty services will pay 13%
  • Computer repair services will pay 10.5%
  • Management consultants will pay 14%
  • Hotels and accommodation will pay 10.5%.

You can see the full list of Flat Rate VAT schemes rates on the HMRC website.

You will receive a 1% discount on your amount in your first year as a Flat Rate VAT-registered business.

The limited cost trader Flat Rate VAT scheme

In April 2017, HMRC implemented new legislation in order to help tackle abuse of the VAT Flat Rate scheme.

This was intended to manage the effect of an increasing number of sole traders, which the Treasury has cited as a cause of decreasing tax revenues.

The introduction of the limited cost trader test means that small businesses (many ‘labour-only’ businesses) with low annual costs pay a flat rate of 16.5% VAT.

Limited cost trader test

If you only pay a small amount on goods you may need to review your VAT status to see if your business is classified as a limited cost trader.

You’ll fit into this category if within your accounting period:

  • Your goods cost less than 2% of your turnover
  • Your goods cost less than £1,000 (if your costs are over 2% of your turnover)

The accounting period is classified as the period in which you submit a VAT return – usually quarterly.

If you’re still unsure whether you fall into the limited cost trader category under the Flat Rate VAT scheme, you can use HMRC’s higher rate calculator.

VAT FAQs

How often do I pay VAT?

You will fill in a VAT return form every quarter. You complete and submit it to HMRC online.

How often do I need to do the limited cost trader test?

Once you’re on the Flat Rate VAT scheme you will be required to do the limited cost trader test every VAT period.

Do limited cost traders still get the 1% discount in the first year of VAT registration on the Flat Rate scheme?

Yes, HMRC has confirmed that limited cost traders do still receive the 1% discount on the Flat Rate VAT scheme for the first year. This reduces the rate for the first 12 months to 15.5%.

What counts as relevant goods when applying the limited cost trader test?

Following the announcement of the limited cost trader test, a number of services have been disallowed as relevant goods.

Here are a few examples that are no longer considered relevant goods:

  • Contractor accountancy fees
  • Advertising costs
  • Electronically downloaded services e.g. magazine subscription
  • Downloaded/bespoke software
  • Office rent costs

If I’m a limited cost trader under the new rules should I leave the Flat Rate VAT scheme?

Many people choose to use the Flat Rate VAT scheme because of ease of use; it means there’s less work for you to do when you’re managing your accounts.

However, with the implementation of the new limited cost trader test, it could be more tax efficient for you to manage your VAT through one of the other schemes, such as the Cash Accounting scheme or the Annual Accounting scheme.

The best way to find out what scheme will work for you is to speak to your own accountant, as they will be most familiar with how your business works and will be able to best advise you on the most suitable course of action.

How do I apply for the VAT Flat Rate scheme?

If you want to apply to join the Flat Rate VAT Scheme, you can do so online, by post, email or phone to HMRC.

To apply by post you must first download a VAT 600 FRS Flat Rate Scheme from HMRC here. After completing it, you should post it to; HM Revenue and Customs – Annual Accounting Registration Unit, Imperial House, 77 Victoria Street, Grimsby DN31 1DB.

To apply by email you’ll need to download the same form and fill it in on your computer. You can then email this back to frsapplications.vrs@hmrc.gsi.gov.uk.

If you’d like to speak to someone before you apply for the scheme, you can ring HMRC’s VAT helpline on 0300 200 3700.

This article has been written exclusively for ByteStart by Lauren Wise from The Accountancy Partnership.

Last updated: 18th February, 2021

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