The amount of VAT a business pays or claims back from HM Revenue and Customs (HMRC) is usually the difference between the VAT charged by the business to customers and the VAT the business pays on their own purchases. This is referred to as the Standard scheme.
How the Flat Rate scheme works
You pay a fixed rate of VAT to HMRC (depending on your business type)
You keep the difference between what you charge your customers and pay to HMRC
You cannot reclaim the VAT on your purchases - except for certain capital assets over £2,000
To join the scheme your VAT turnover must be £150,000 or less (excluding VAT), and you must apply to HMRC.
When you register for the Flat Rate scheme for the first time, HMRC allows you to apply a 1% discount in the first year.
For further information on the flat rate scheme, please click here.
Limited Cost Trader
If you are considered what is known as being a limited cost trader, then you would be subject to a flat rate sector of 16.5% (if it’s your first year of VAT registration then you would still receive the 1% discount bringing the percentage down to 15.5%). This isn’t too dissimilar to just being on the standard VAT scheme, but without the added benefit of being able to reclaim any VAT on your expenses.
For example:
£1,000 net sale (charge for service)
£200 charge for VAT
£1,200 gross sale
Flat rate = 16.5%
VAT payable to HMRC = £1,200 x 16.5% = £198
The difference between VAT collected and paid here is only £2.
A limited cost trader is defined as one whose VAT inclusive expenditure on goods in the VAT accounting period are less than the higher of the following criteria:
● 2% of relevant VAT inclusive turnover for the quarter
● Greater than 2% of their VAT inclusive turnover but less than £1,000 per annum (so less than £250 per quarter)
Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:
● Capital expenditure
● Food or drink for consumption by the flat rate business or its employees
● Vehicles, vehicle parts and fuel
To decide if this affects you then you need to consider what expenditure you have in the way of tangible goods used within the business (including stationery, printed materials, hardware, computer consumables) and your direct costs of sales (excluding delivery/transport, subcontractors, web hosting).