Flat Rate Scheme

Flat Rate Scheme

Flat Rate Scheme
The Flat Rate Scheme (FRS) is a simplified VAT system whereby a business pays a fixed percentage of its VAT taxable turnover to HMRC. Your VAT taxable turnover is the total of all sales that would either have VAT added to them or are 0% rated. It does not include sales that are exempt from VAT. 
 
Its main advantage is that it is simple to use but usually comes at a cost, as most businesses would pay less VAT under the standard scheme.
 
​VAT on expenses is called Input VAT. VAT on sales is called Output VAT. Under the standard scheme, a business pays HMRC the difference between its sales VAT less its expenses VAT. If the input VAT exceeds the output VAT, HMRC will refund the company. However, under the FRS, as input VAT is not ordinarily deducted, VAT will only be due if there are sales subject to VAT. 
 
Requirements for scheme
To be eligible to join the scheme, you must have a VAT-taxable turnover of under £150,000. If this exceeds £230,000, you must leave the scheme and use the standard scheme. You cannot rejoin the scheme if you left it within the last 12 months. 
 
Rules of the scheme
  1. Apart from your first VAT return, you cannot claim input VAT on expenses
  2. Input VAT on capital items of £2,000 or more (VAT inclusive) is permitted  
  3. 1% discount is available for the first year
  4. If you are a limited-cost trader, you will have to use the 16.5% rate
 
Limited cost trader rule
A Company will be classified as a limited-cost trader if it spends less than 2% of its sales or £250 in a quarter on expenses that are not "relevant goods". This typically applies to service-based companies where there are low costs compared with a “buy and sell” business with considerable costs of sale. The flat rate applied usually depends on your business sector and can be as low as 4%, but all limited-cost traders must use 16.5%. As this 16.5% is levied on the VAT-inclusive figure, it works out at almost the same as 20% on the net figure under the standard scheme. For more information, please see section 4 of this HMRC notice, which lists various expenses to show that even most vatable expenses do not qualify for the 2%.
 
Standard scheme: £100+VAT = £20 to HMRC
 
Flat Rate Scheme: £100+VAT = £120*16.5% = £19.80 to HMRC.
 
The difference is unlikely to be 20p since under the standard scheme you can deduct any VAT on expenses, which you cannot on the FRS.
 
Examples
A business is preparing its VAT return under the FRS, having already used it for the last year. In the previous 3 months, it has £10,000+VAT of sales and expenses of just £300+VAT of accountancy fees.
 
It will pay HMRC 10,000+VAT = £12,000 x 16.5% = £1,980
 
Under the standard rate scheme, it would have had £2,000 of output VAT (10,000*20%) on the sales and £60 of input VAT (300*20%) on the accountancy expenses. It would have paid £2,000-£60 = £1,940 to HMRC.
 
As you can see, even with a monthly accountancy fee of £100, a business would be £40 worse off under the FRS. Most companies would have more vatable expenses than just accountancy fees too.
 
If this was the first year of registration and the business qualified for the 1% discount, the VAT figure would be: 
 
12,000* 16.5-1% = £1,860
 
To match this, a business under the standard rate scheme with £10,000+VAT of sales would need to have £700+VAT of expenses in a quarter. 
£2,000-£140 = £1,860
 
Conclusion
The FRS can be marginally profitable if you have almost no VAT expenses in the first year due to the 1% discount. However, by year 2, virtually no business would be financially benefiting from remaining on the FRS as they would lose out by being unable to reclaim expenses, with no discount on the sales. There is nothing stopping a company from registering for VAT under the FRS, benefiting from the 1% discount and then switching to the standard rate scheme for the second year.
 
We can prepare your VAT return from just £30+vat a month. Under the standard scheme, you would be able to reclaim the VAT. So the cost to the company is £30 a month, falling to as low as £22.50 a month effective after allowing for corporation tax relief on the expense. So even if you are unsure of the process, paying us to do this for you can still be tax efficient.
  


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