Introduction
If you run a small business in the UK, VAT can be a major administrative burden. The Flat Rate VAT Scheme (FRS) was introduced by HMRC to simplify VAT reporting, but is it the right option for your business?
In this guide, we will compare the Flat Rate VAT Scheme vs Regular VAT Scheme, covering the advantages, disadvantages, and cost-benefit analysis to help you make an informed decision.
What is the Flat Rate VAT Scheme?
The Flat Rate VAT Scheme (FRS) allows small businesses to pay VAT at a fixed percentage of their total turnover instead of tracking VAT on every individual sale and purchase.
- Businesses charge VAT at 20 per cent on their invoices.
- Instead of paying 20 per cent VAT to HMRC, they pay a lower fixed rate (set by HMRC based on the industry).
- Businesses cannot reclaim VAT on purchases, except for capital assets over £2,000.
This scheme is only available to businesses with a turnover of £150,000 or less (excluding VAT). If turnover exceeds £230,000, the business must leave the scheme.
Advantages of the Flat Rate VAT Scheme
1. Reduced Administration and Simplicity
- No need to track VAT on every sale and purchase.
- Simplifies VAT reporting, reducing paperwork and errors.
- Easier cash flow forecasting.
2. Potential VAT Savings
- Some businesses end up paying less VAT than they collect.
- For example, an IT consultant with a 14 per cent flat rate would pay 14 per cent of total turnover, keeping the difference.
3. First-Year Discount
- New VAT-registered businesses receive a 1 per cent discount on their flat rate for the first 12 months.
4. No Need to Reclaim VAT on Purchases
- Saves time by not needing to track VAT on business expenses.
Disadvantages of the Flat Rate VAT Scheme
1. Higher VAT Payments for Some Businesses
- If a business has high VATable expenses, it may pay more VAT compared to the Regular VAT Scheme, since VAT cannot be reclaimed on purchases.
2. Not Beneficial for Zero-Rated or VAT-Exempt Sales
- Businesses with zero-rated or VAT-exempt sales still pay VAT at the flat rate, reducing profitability.
3. Limited Cost Trader Rule
- If a business spends less than 2 per cent of turnover (or under £1,000 per year) on goods, it is classified as a Limited Cost Trader and must use a higher flat rate of 16.5 per cent, making the scheme less attractive.
4. Not Suitable for High-Expense Businesses
- Businesses that regularly purchase VATable goods and services are better off under the Regular VAT Scheme since they can reclaim VAT.
Flat Rate VAT vs Regular VAT: Cost-Benefit Analysis
Example Calculation: Which VAT Scheme is Cheaper?
Scenario 1: Service-Based Business (Better for Flat Rate VAT Scheme)
- Turnover: £100,000 + VAT (£120,000 total)
- Flat Rate VAT percentage: 14 per cent (for IT consultants)
- VAT payable to HMRC: 14 per cent of £120,000 = £16,800
- VAT charged to clients: £20,000 (20 per cent of £100,000)
- Business keeps: £3,200 in VAT savings
Scenario 2: High-Expense Business (Better for Regular VAT Scheme)
- Turnover: £100,000 + VAT (£120,000 total)
- VATable expenses: £20,000 (includes £4,000 VAT)
- VAT collected: £20,000
- VAT reclaimed: £4,000
- VAT due to HMRC: £16,000
- Business saves £800 compared to FRS
If expenses are low, the Flat Rate VAT Scheme can lead to savings. If expenses are high, the Regular VAT Scheme is usually more beneficial.
Should You Choose the Flat Rate VAT Scheme?
Choose Flat Rate VAT Scheme if:
✔ Your business has low VATable expenses (for example, consultants, freelancers).
✔ You want simple VAT accounting and less admin.
✔ You qualify for the 1 per cent first-year discount.
✔ You do not make a lot of VATable purchases.
Choose the Regular VAT Scheme if:
✔ Your business buys a lot of goods/services with VAT.
✔ You want to reclaim VAT regularly.
✔ Your business exports goods/services that are zero-rated.
✔ You do not mind tracking VAT in more detail.
Conclusion: Which VAT Scheme is Right for You?
Choosing between the Flat Rate VAT Scheme and the Regular VAT Scheme depends on your business model, expenses, and cash flow.
- If you have few VATable purchases, the Flat Rate VAT Scheme may save you money and reduce admin.
- If you regularly reclaim VAT on purchases, the Regular VAT Scheme is likely a better option.
Before making a decision, compare your VAT liabilities under both schemes to ensure you are making the most tax-efficient choice.
If you need personalised VAT advice, feel free to contact me at david.levy@fkgb.co.uk and I will be happy to assist you!
