The VAT flat rate scheme (often abbreviated to VAT FRS) is an alternative way for small businesses to calculate how much VAT they will pay to HMRC each quarter.
The scheme is designed to help SMEs by making it easier to complete VAT returns, with the added bonus that it can often result in a cash saving.
Under the standard VAT scheme (i.e. not the flat rate scheme) a business records the VAT on its sales (usually at 20%) and the VAT on its purchases then pays over to HMRC the difference between these figures.
Under the flat rate scheme, a single percentage rate is applied to sales, and this amount is reported (and paid) to HMRC quarterly. You can’t reclaim VAT on purchases unless you buy a capital asset that costs over £2,000 including VAT (but beware – you would need to pay VAT on such an asset if it was ever sold). The flat rate percentage depends on the business sector and a list of these sectors and related flat rate percentages can be found on the HMRC website.
The scheme is for businesses with a turnover (excluding VAT) of no more than £150,000 per year. Once in the scheme, a business may prepare VAT returns under the flat rate scheme until its turnover (including VAT) exceeds £230,000.
When you are using the flat rate scheme you still charge VAT to your customers in the normal way so your customers would not notice any change.
For example, an IT consultancy company with a turnover of £120,000 may have very little expenditure with VAT on. Under the standard scheme, they would charge their customers £120,000 + 20% = £144,000 per year, but pay over to HMRC £24,000 of VAT on sales, less any VAT on purchases.
Under the flat rate scheme, their percentage figure would be 14.5%. Their sales invoices to customers would be exactly the same as under the standard VAT scheme, but now they would pay over to HMRC £144,000 * 14.5% = £20,880, a saving of £3,120. As an additional benefit, HMRC are currently allowing a 1% reduction in the flat rate percentage for businesses in the first year of VAT registration. In the example above this would increase the saving to £4,560 if the company registered for VAT under the flat rate scheme immediately.
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