Which is best – Standard VAT or Flat Rate VAT (FRS)?
Simple, but not very helpful, answer is, “It depends”
How do the two schemes work?
With standard VAT, you charge VAT on your sales and pay this over to HMRC. Before paying the money to HMRC, you deduct any VAT charged to you on your purchases. This is a pretty simple process, you buy a widget for £50 plus VAT (VAT = £10). You sell the widget for £100 plus VAT (VAT = £20). You pay the difference to HMRC = £10 (£20 – £10).
And you can also deduct the VAT on any incidental costs before paying the money to HMRC.
With Flat Rate VAT, you cannot reclaim any VAT you have been charged (except for some exceptional circumstances). Instead, the VAT you need to pay to HMRC is calculated on your VAT inclusive sales.
The flat rate to be used depends on your main trade or profession. HMRC publishes a list of trades and professions and you have to choose the one which fits your business best. The list can be found at https://www.gov.uk/vat-flat-rate-scheme/how-much-you-pay
It is up to you which flat rate you use. HMRC will not help you decide. However, if you subsequently have a VAT inspection, the VAT inspector will look at your choice and can disagree and charge VAT retrospectively. It pays to be careful in choosing your rate.
If you think that the FRS (Flat Rate Scheme) will be of benefit to you, you can join if you expect your turnover to be less than £150,000 in the next 12 months.
There are a few other restrictions which prevent you from joining. These are if
- you left the scheme in the last 12 months
- you committed a VAT offence in the last 12 months, eg VAT evasion
- you joined (or were eligible to join) a VAT group in the last 24 months
- you registered for VAT as a business division in the last 24 months
- your business is closely associated with another business
- you’ve joined a margin or capital goods VAT scheme
Once in the scheme you must leave if your turnover for the previous 12 months exceeded £230,000 (including VAT) on the anniversary of joining the scheme.
VAT on purchases which can be claimed under the FRS
Most VAT paid on purchases cannot be reclaimed if you are using Flat Rate VAT. However, if you purchase a capital asset costing £2,000 or more, the VAT can be reclaimed. This extends to “packages” if bought from one supplier at one time. One example given by HMRC is a package consisting of a computer, printer, camera, scanner, monitor etc). If bought separately, they probably wouldn’t qualify but buy them together on one invoice from one supplier and, provided the total is greater than £2,000, VAT can be reclaimed.
Comparison of VAT rates
This is something which can cause confusion. Comparing two quoted rates is not comparing apples with apples. Standard VAT is calculated on the Net or VAT exclusive price but flat rate VAT is calculated on the VAT inclusive figure.
As an example, let us say you are a hairdresser selling a service for £100 plus VAT or £120 inclusive. The standard VAT rate is 20% and this is applied to the net price. So you owe HMRC £20.
The flat rate for hairdressers is 13%. This is applied to the VAT inclusive figure; in this case £120, so the amount you owe HMRC is 13% of £120 or £15.60.
The difference is that under the flat rate scheme, you must pay £15.60 to HMRC. Under the standard scheme, you can deduct any VAT you pay on purchase of supplies and other incidental costs (rent, electricity, accountancy fees, etc).
As you can probably gather from the example, the overall difference probably isn’t great. HMRC estimates that FRS is broadly neutral. In other words, some businesses gain and some lose but HMRC collects roughly the same amount as they would under standard VAT.
When we have done the calculations retrospectively, we have often found that a business would often have paid less VAT under the standard scheme than under the FRS. FRS was introduced back in the days of paper bookkeeping and simple tills to make the calculation easy and quick. Nowadays it is relatively simple to produce accurate VAT Returns so there isn’t the saving in time there used to be.
Limited Cost Business
There is a sting in the tail for some businesses using FRS. If a business spends less than 2% of turnover on goods or £1,000 per year, the usual flat rate percentage is ignored and a rate of 16.5% is applied. This has to be checked for every VAT Return submitted.
Ask for advice
You would probably expect us to say this – but you know it makes sense.
There are other VAT schemes – Cash, Annual Accounting etc. VAT can become even more complicated if you are buying or selling abroad or your goods/services can have different VAT rates. Call us to discuss your options.