Tax

What is VAT Flat Rate Scheme?

The Flat Rate Scheme is a simplified VAT scheme where you pay a fixed percentage of your turnover to HMRC, instead of calculating VAT on each transaction.

Current Rate (2025/26)

Varies by industry: 11-16.5% typically

Example

You're a consultant (12% rate). Invoice £10,000 + £2,000 VAT = £12,000. Pay HMRC 12% of £12,000 = £1,440. Keep £560 difference.

Key Dates

Can join if taxable turnover under £150,000

How VAT Flat Rate Scheme Works in Practice

The VAT Flat Rate Scheme (FRS) is a simplified way of accounting for VAT designed to reduce the administrative burden on small businesses. Instead of calculating VAT on every individual purchase and sale, you apply a single flat rate percentage to your gross (VAT-inclusive) turnover and pay that amount to HMRC. You still charge VAT at the standard rate on your invoices, but you do not reclaim input VAT on purchases (with one exception for capital goods over £2,000).

The flat rate percentage varies by business sector, ranging from 4% for retailing food and similar goods to 16.5% for accountancy, law, and management consultancy. HMRC publishes a full list of sectors and their rates. In the first year of VAT registration, you receive a 1% discount on the applicable rate.

The scheme was originally attractive because many service businesses (especially those with low costs) kept the difference between the VAT charged to customers and the flat rate payment to HMRC. However, HMRC introduced the limited cost trader category in April 2017. If your purchases of goods (not services) are less than 2% of your VAT-inclusive turnover, or less than £1,000 per year, you are classified as a limited cost trader and must use a flat rate of 16.5% instead of your sector rate. This effectively eliminates the VAT saving for most service businesses with low goods costs.

You can join the FRS if your taxable turnover (excluding VAT) is £150,000 or less. You must leave if your total income (including VAT) exceeds £230,000 in any 12-month period.

Step by Step

Each quarter, you calculate your VAT-inclusive turnover (all standard-rated, reduced-rated, and zero-rated income including the VAT you charged). You multiply this by your flat rate percentage to determine what you owe HMRC. You do not need to calculate input VAT on each purchase separately.

For example, as an IT consultancy with a 14.5% rate, if your VAT-inclusive turnover for the quarter is £36,000, you pay HMRC 14.5% of £36,000 = £5,220. You charged £6,000 in VAT on your invoices (20% of £30,000 net), so you keep the £780 difference. However, if you are a limited cost trader, you use 16.5% instead, paying £5,940 and keeping only £60.

The one exception to not reclaiming input VAT is for capital goods costing £2,000 or more including VAT (a single item, not aggregated purchases). You can reclaim the VAT on these purchases on top of the flat rate calculation. This makes the scheme slightly more beneficial if you occasionally make large capital purchases.

Practical Tips

  • Before joining the Flat Rate Scheme, calculate your VAT liability under both the FRS and standard VAT for at least two quarters to see which is cheaper
  • Check whether you are a limited cost trader by tracking your goods purchases as a percentage of turnover, since this determines whether you pay your sector rate or 16.5%
  • Keep records of any capital goods purchases over £2,000 so you can reclaim the VAT on top of your flat rate payment
  • Review annually whether the scheme is still beneficial, especially if your business costs or turnover have changed significantly

Common Mistakes to Avoid

  • Assuming the Flat Rate Scheme always saves money without checking whether you qualify as a limited cost trader, which applies the 16.5% rate and often makes the scheme more expensive than standard VAT
  • Using the wrong sector category and flat rate percentage, which HMRC can discover during an inspection and adjust retrospectively with penalties
  • Forgetting that the flat rate is applied to VAT-inclusive turnover, not net turnover, which is a common calculation error
  • Not reclaiming VAT on qualifying capital goods over £2,000, which is the one input VAT recovery allowed under the scheme

Frequently Asked Questions

Is the VAT Flat Rate Scheme worth it?

It depends on your business type and costs. If you are a service business with very few goods purchases, you are likely a limited cost trader paying 16.5%, which is usually worse than standard VAT accounting. If you have moderate goods costs and a low sector rate, the scheme can save both time and money. Run the numbers both ways before joining.

What is a limited cost trader?

A limited cost trader is a business whose purchases of goods (not services) are less than 2% of VAT-inclusive turnover, or less than £1,000 per year. Limited cost traders must use a flat rate of 16.5% regardless of their sector category. This rule was introduced to prevent pure service businesses from profiting unduly from the scheme.

Can I reclaim VAT on purchases under the Flat Rate Scheme?

Generally no. Under the FRS, you do not reclaim input VAT on regular purchases. The only exception is for individual capital goods costing £2,000 or more including VAT. For these items, you can reclaim the VAT in addition to paying your flat rate amount.

How do I leave the Flat Rate Scheme?

You must leave if your total business income exceeds £230,000 in any 12-month period. You can also choose to leave voluntarily at any time by writing to HMRC. You must have been on the scheme for at least 12 months before you can leave voluntarily. When you leave, you revert to standard VAT accounting.

What flat rate percentage does my business use?

HMRC publishes a list of trade sectors with corresponding flat rate percentages on GOV.UK. You use the rate for the sector that most closely matches your main business activity. Rates range from 4% to 16.5%. In your first year of VAT registration, you get a 1% discount on the applicable rate.

Source: HMRC VAT Notice 733 - Flat Rate Scheme for small businesses

Related Terms

VAT (Value Added Tax)

VAT is a tax added to most goods and services sold in the UK. Businesses collect it from customers and pay it to HMRC, minus any VAT they've paid on business purchases.

VAT Return

A VAT return is a regular submission to HMRC showing the VAT you've charged (output VAT) and paid (input VAT), with the difference paid or reclaimed.

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