The Flat Rate VAT scheme can sound like a DREAM for business owners reaching the VAT threshold (£90,000 rolling 12 month turnover, as of April 2024)
”I can pay less than 20% VAT on my sales?? I’m sold!”
Essentially, it means that businesses pay a lower percentage of VAT on their sales, but cannot claim back the VAT on any of their purchases. (Learn all about the basics of VAT here!)
Unfortunately, may business owners who see the shiny low % of VAT to pay, can then miss the small print (cause who reads that right🤷🏼♀️🫣), which can lead to trouble with HMRC, and ultimately, not save them any money at all 🙁
What’s the deal then? What’s the small print all about?
Firstly, you can only join the scheme if your turnover during the next 12 months is expected to be £150,000 (excluding VAT) or less AND you will have to leave the scheme once your 12 month turnover (including VAT) exceeds £230,000. (we knew they weren’t going to make this simple, right??)
Also worth noting is that the % of Flat Rate VAT changes depending on the industry you’re in! You could be anywhere from a mere 6.5% for agriculture, to 14.5% as an accountant!
And, as with many good tax saving opportunities, the government eventually cotton on that they’re missing out on potential tax and stop them!
In April 2017, it was the VAT Flat rate scheme that they changed, meaning that many businesses were no longer eligible to use that lovely low flat rate percentage.
They brought in something called low cost trader or limited cost business. And it means that to use the Flat Rate % rate for your industry, you need to spend a certain amount on physical, movable goods in your business. If you don’t spend enough, then you are a ‘low cost trader’ and need to use a higher % – which actually means you’d very likely be worse off than using the normal VAT rules.
Who would be a low cost trader?
You’re a low cost trader if the amount you spend on relevant goods including VAT is either:
- less than 2% of your VAT flat rate turnover (sales figure)
- greater than 2% of your VAT flat rate turnover (sales figure) but less than £1,000 per year
(Yay, more maths!🤯)
So for example – if your sales are £10,000 per year, you need to spend over £200 per year on relevant goods or you’d be classed as a low cost trader.
Now this doesn’t sound a lot – but think about what you actually do spend money on – especially if you’re a service based business, without may physical costs.
What are classed as relevant goods?
Relevant goods are moveable items or materials exclusively used in your business. You can also include gas and electricity. If you’re estimating your annual spend then you need to use realistic figures.
It may be easier to start with what isn’t classed as relevant goods:
- any services – which is anything that isn’t goods (ie not physical things!)
- expenses like travel and accommodation
- food and drink eaten by yourself or your team
- vehicle costs including fuel, unless you’re in the transport industry
- rent, internet, phone bills and accountancy fees
- gifts, promotional items and donations
- goods you will resell or hire out, unless this is your main business activity
- training and memberships
- capital items for example office equipment, laptops, mobile phones and tablets
OK – so now for some examples of what DO count as relevant goods:
- stationery and other office supplies to be used exclusively for the business
- gas and electricity used exclusively for your business
- stock for a shop
- cleaning products to be used exclusively for the business
- products needed to provide your services eg hair products in a salon
- food to be used in meals for customers
- goods provided by a subcontractor and itemised separately
- goods brought into the UK if they are not otherwise excluded
- goods bought without VAT being charged, if they are not otherwise excluded – ie they don’t qualify for VAT (like stamps) or the person you’re buying from isn’t VAT registered (and therefore doesn’t charge you VAT)
Please note – this is not a full list but the most common ones.
By now, you should have a rough idea of whether or not you would be a ‘low cost trader’; so scroll down to read how the scheme would work in your circumstances.
I don’t think I would be a ‘low cost trader’, so how does it work for me?
Let’s use the example of a hairdresser. This industry uses the Flat Rate of 13%.
So sounds like you’ll be 7% better off, keeping 7% more of your sales, right?
Let’s see…
Imagine your sales are £100,000 – you would pay £13,000 in VAT.
But what would you pay on a normal VAT scheme? £20,000?
Nope.
That £100,000 represents your GROSS sales, meaning that truly, it needs dividing by 6 to find your VAT (VAT is 20% added on top of the sale price). So straight away, your VAT is down to £16,666.66.
”Okay, but I’m still saving £3666 though…”
How much do you spend on expenses & purchases with VAT throughout the year? Because on the normal VAT scheme, you’ll be able to offset every penny of VAT you have SPENT against the VAT you owe.
Because when you pay for goods & services, the VAT is included, the VAT represents 20% of what you have paid.
So, if the VAT on your purchases throughout the year is £3666 or more, then you would pay LESS VAT by reporting 20% of your sales instead of 13% 🤯
And how much would those expenses need to be? Around £22,000.
These were nice round numbers, and we know that not many businesses work in nice round numbers, but you get the point! With a few minutes spent doing some sums, you can be certain that you will make the best choice.
So, if I’m a low cost trader what % do I use?
The rate for a low cost trader is 16.5% – which doesn’t sound too bad – better than 20% right?!
But when you actually do the math you more than likely end up paying more than if you just took your 20% charged on sales less 20% of all your VAT-rated purchases.
For the MAJORITY of low-cost traders, we’d totally recommend just sticking to the standard way of doing VAT.
Then, there is the decision between the Cash or Accrual scheme. You can read more on the different ways of doing VAT here.
What if I’m using the wrong flat rate %?
First off – don’t panic – we can fix this for you, but unfortunately it could mean having to pay a bit extra over to the tax man. We’ve had a few clients fall into this trap before they’ve joined us, so know you’re not alone and it is fixable. And HMRC won’t expect you to pay the extra tax in one go – especially if it goes back a while. You will be able to set up a payment plan to ease the burden on your cashflow.
Help – this all makes my head hurt!
We’ve got you covered, don’t stress 🙂
We totally get that getting the right way of doing VAT is confusing, and you certainly didn’t set up your business to work out how to do your VAT returns!
But we did! So let us take this stress off your shoulders so you can focus on what you do love to do. We can make sure you’re set up in the right way so it doesn’t come back and bite you down the line.
Just pop over to our Get Started page, fill in the quick questionnaire and we can make sure you’re doing your VAT in the right way and keeping the tax man off your back.
