Flat Rate VAT vs standard
The Flat Rate Scheme can leave a small business better or worse off depending on the sector rate and how much VAT it can reclaim. This shows which one leaves you with more.
The two schemes side by side
| Line | Flat Rate Scheme | Standard |
|---|---|---|
| VAT charged to customers | £12,000 | £12,000 |
| Paid to HMRC | £10,440 | £11,000 |
| Input VAT reclaimed | None | £1,000 |
| You keep | £1,560 | £1,000 |
How it is worked out
Under both schemes you charge customers the standard 20%, so the VAT they pay you is the same. The difference is what you hand to HMRC. On the Flat Rate Scheme you pay a flat percentage of your gross turnover, meaning turnover plus the VAT you added, and you keep the gap between the VAT you charged and that flat payment. You cannot reclaim VAT on purchases except for large capital assets. Under standard accounting you pay the VAT you charged minus the VAT on everything you bought, so the money you keep is simply the input VAT you reclaim.
The scheme rewards businesses that spend little on standard-rated goods, because they give up a reclaim that was small anyway while keeping a share of the flat rate margin. Once you are classed as a limited cost trader the rate jumps to 16.5%, which on a 20% charge leaves almost nothing, so the scheme rarely pays for service-only businesses after the first-year discount ends.
Worked example
On £60,000 of turnover you charge £12,000 of VAT. At a 14.5% flat rate you pay HMRC £10,440 and keep £1,560. Under standard accounting you reclaim £1,000 on £5,000 of costs, so you keep £1,000. That makes the flat rate scheme better by £560, before you account for the tax due on any flat rate surplus.
Common questions
How does the Flat Rate Scheme work?
You still charge your customers 20% VAT, but instead of paying HMRC that VAT minus your input VAT, you pay a single flat percentage of your gross, VAT-inclusive turnover. You keep the difference between the VAT you charged and the flat amount you hand over. In return you give up the right to reclaim VAT on most purchases.
What is the 16.5% limited cost trader rate?
It is an anti-avoidance rate. If your spending on goods is less than 2% of turnover, or less than £1,000 a year, you are a limited cost trader and must use 16.5% whatever your sector rate would be. Most consultants and labour-only contractors fall into this, which wipes out almost all of the flat rate benefit.
Is the flat rate scheme worth it on £60,000 turnover?
At £60,000 turnover with a 14.5% sector rate and £5,000 of reclaimable costs, the flat rate scheme comes out ahead by about £560 a year. The answer changes as soon as your reclaimable costs rise or the limited cost rate applies.
Is the flat rate surplus taxable?
Yes. Anything you keep from the scheme, the gap between the VAT you charged and the flat amount you paid, counts as income and is taxed as profit. So the headline saving is not all yours; deduct your income tax or corporation tax rate to see the real benefit.
When does standard VAT accounting win?
Standard accounting is better when you buy a large volume of standard-rated goods or services, because you reclaim the VAT on all of it. Trades with real material costs, or anyone making large equipment purchases, are usually better off standard. The scheme suits low-cost, service-heavy businesses on a generous sector rate.