Should I Use the VAT Flat Rate Scheme as a New Business?

Introduction

If you have recently registered your business for VAT, you might have come across something called the Flat Rate Scheme (FRS). It is designed to simplify VAT reporting for small businesses by making calculations easier and reducing paperwork. But is it the right choice for your new business?

The Flat Rate Scheme can save time and, in some cases, money. However, it is not suitable for every business type. This article explains how it works, who can use it, what the advantages and drawbacks are, and how to decide whether it fits your situation.

What Is the VAT Flat Rate Scheme?

The VAT Flat Rate Scheme is an alternative way to calculate VAT owed to HMRC. Instead of claiming back VAT on every purchase and charging VAT on every sale, you apply a single fixed percentage to your gross turnover. This percentage depends on your industry sector.

You still charge customers the standard rate of VAT (usually 20%) on your invoices, but you pay HMRC a lower, fixed percentage of your total VAT-inclusive sales. The difference between what you collect and what you pay is yours to keep, covering the VAT you have paid on expenses.

For example, if your flat rate percentage is 12%, and your VAT-inclusive sales are £10,000, you pay HMRC £1,200 (12%) instead of calculating VAT line by line.

Who Can Use the Scheme?

You can join the Flat Rate Scheme if:

• Your expected VAT turnover (excluding VAT) is £150,000 or less in the next 12 months.

• You are a VAT-registered business.

• You are not part of a VAT group or margin scheme.

• You do not spend most of your money on goods that fall under the limited-cost business category (more on this below).

Once you join, you can remain in the scheme until your total turnover exceeds £230,000 in any 12-month period.

How the Flat Rate Scheme Works

Each industry has its own percentage rate set by HMRC. For example:

• Accountancy or legal services: 14.5%

• Retail: 7.5%

• Construction: 9.5%

• Catering: 12.5%

• IT or consultancy: 14.5%

You pay this percentage on your VAT-inclusive turnover, not your net sales. So if you charge £10,000 plus £2,000 VAT, your total turnover is £12,000. You then multiply £12,000 by your flat rate percentage.

In your first year of VAT registration, you can reduce your flat rate percentage by 1%, which can make the scheme slightly more beneficial when starting out.

What Is a Limited-Cost Business?

HMRC introduced additional rules in 2017 to prevent service-based businesses with very few goods purchases from gaining an unfair advantage.

If you spend less than 2% of your turnover or less than £1,000 per year on goods (excluding services and capital items), you are classed as a limited-cost business.

Limited-cost businesses must use a higher flat rate of 16.5%, which often removes any financial advantage of using the scheme. This category includes many consultants, designers, and contractors who mainly sell services rather than goods.

Advantages of the Flat Rate Scheme

• Simpler bookkeeping: You do not need to track VAT on every expense.

• Time saving: VAT returns are quicker to prepare, reducing admin.

• Predictable VAT payments: You know what percentage of turnover goes to HMRC each quarter.

• Cash flow benefits: If your expenses are low, the scheme may allow you to keep a small margin between what you charge and what you pay to HMRC.

• 1% discount in the first year: New VAT-registered businesses benefit from a small temporary reduction.

For small firms with straightforward transactions, these advantages can make managing VAT far easier.

Disadvantages of the Flat Rate Scheme

• Limited ability to reclaim VAT: You generally cannot claim VAT back on purchases, except for large capital items over £2,000.

• May cost more if you buy a lot of goods: If your business has high expenses with VAT included, the standard VAT scheme might work out cheaper.

• Limited-cost business rate: The 16.5% rate can make the scheme unhelpful for service-based businesses.

• No flexibility on rates: The percentage is fixed by HMRC, even if your business has unusual costs or mixed supplies.

Before joining, you should ask your accountant to run a comparison between the standard VAT scheme and the Flat Rate Scheme based on your expected turnover and expenses.

Example Scenario

Imagine Ben, who runs a small web design company. His turnover is £60,000 per year, and he has minimal VAT-eligible expenses because most of his costs are software subscriptions and freelance help.

Under the standard VAT scheme, he would charge clients 20% VAT and reclaim a small amount of input VAT on expenses. Under the Flat Rate Scheme, his sector rate is 14.5%.

If his VAT-inclusive sales are £72,000, he would pay HMRC £10,440 (14.5%). After subtracting the VAT he collected (£12,000), he keeps £1,560 as his effective allowance for VAT on expenses.

However, if Ben spends more than expected on equipment or subcontractors, the standard scheme could offer better value because he could reclaim VAT on those purchases.

When the Flat Rate Scheme Works Best

The scheme works well for:

• Small businesses with low VAT-eligible expenses

• Service-based industries with simple bookkeeping needs

• Start-ups that want to save time in their first year

• Businesses that value simplicity over maximising every possible VAT reclaim

It is particularly attractive for new businesses that do not buy much stock or equipment and want predictable VAT payments each quarter.

When It Might Not Be Suitable

The scheme may not be worthwhile if your business:

• Buys a lot of stock, materials, or equipment

• Frequently reclaims VAT on large purchases

• Falls under the limited-cost business rate

• Expects to grow quickly and exceed the turnover limit within a year

If your business spends heavily on VAT-registered goods or capital items, the standard VAT scheme usually gives better results.

How to Join the Flat Rate Scheme

If you decide it is right for your business, you can apply directly through your HMRC VAT account after registering for VAT. Once accepted, you start using your sector’s flat rate percentage from the beginning of your next VAT period.

If you later find the scheme is no longer beneficial, you can switch back to the standard VAT scheme by notifying HMRC. Your accountant can help with both the application and exit process.

Professional Advice Is Key

While the Flat Rate Scheme can be straightforward, it is not a one-size-fits-all solution. The best approach is to have your accountant calculate both scenarios using your actual or forecast figures. They can show whether the scheme saves money or if you would be better off using the standard method.

For many new businesses, the simplicity alone can justify using it in the first year, but it is important to review it regularly as your business grows.

Conclusion

The VAT Flat Rate Scheme can be a useful option for new small businesses that want to simplify VAT reporting and reduce admin. It offers predictable payments and less paperwork, but it is not always the most cost-effective choice.

If your expenses are low and you prefer simplicity, it could work well. However, if you buy significant goods or fall under the limited-cost business category, the standard VAT scheme may save you more money.

Before deciding, speak with your accountant. They can compare both options and help you choose the most tax-efficient scheme for your business.