A summary of eligibility and how to implement and manage the flat rate scheme. The flat rate scheme is designed to help small businesses by applying a single percentage rate to the turnover in a VAT period.
The main benefit of the scheme is the time saved recording VAT on sales and purchases. This can also take some of the stress out of completing VAT returns at the quarter end.
Eligibility to join the scheme The scheme is for businesses with a turnover of no more than £150,000 a year. A business may stay in the scheme provided the total income (including VAT) for the year has not risen above £230,000. If turnover exceeds the £230,000 limit but is expected to fall below £191,500 in the following year, the business may be able to remain in the scheme with HMRC’s agreement.
Turnover represents all the supplies the business makes, including VAT. This includes all of the following:
the VAT inclusive sales and takings for standard rate, zero rate and reduced rate supplies
the value of exempt income, such as any rent or lottery commission – these examples are not exhaustive
supplies of capital expenditure goods, unless they are supplies on which VAT has to be calculated outside the Flat Rate Scheme
the value of any despatches to other Member States of the EC if the business is making intra EC supplies.
Excluded from turnover are private income, bank interest, the proceeds from the sale of goods not used in the business, non-business income and any supplies outside the scope of UK VAT.
Ineligibility A business cannot join the scheme if it:
is not registered for VAT
uses the second-hand margin scheme or the auctioneers’ scheme
is required to use the tour operator’s margin scheme
is required to operate the Capital Goods Scheme for certain capital items
has stopped using the Flat Rate Scheme in the 12 months before the date of a new application
is closely linked with another business.
Determining the flat rate percentage The flat rate percentage depends on the business sector; the correct sector is the one that most closely describes what the business will be doing in the coming year.
HMRC will not normally check the choice of sector when it processes the application. Some business activities can reasonably fit into more than one sector. As long as the initial choice was reasonable, HMRC is not likely to request to change it.
If the business includes supplies in two or more sectors, the percentage used must be appropriate to the main business activity as measured by turnover. That is the sector for which the business gets the greater part of its turnover. The business cannot split the turnover, or apply more than one percentage.
If the balance changes but the business continues to do all the same activities, it should carry on using the percentage that was appropriate at the start of the year until the anniversary of joining the scheme. If on anniversary date the balance has changed, or is expected to change over the year ahead, the rate should switch to the trade sector which forms the larger portion of the business’ expected turnover.
If the business changes the nature of its trade but remains eligible to use the Flat Rate Scheme, it should apply the flat rate percentage appropriate to the trade sector for the new type of business from the date of the change. HMRC must be informed about the change within 30 days of the date of the change.
Reduction of 1% for new VAT registrations If the business is in its first year of VAT registration, it is entitled to a 1% reduction in flat rate. Note that the entitlement to apply the reduction runs for the 12 months following the date of registration for VAT and not the date that the business joins the flat rate scheme. Output VAT and sales invoices The business should record VAT on sales invoices using the normal rate for the supply (standard, reduced or zero rate or exempt) and not the flat rate percentage assigned.
At the end of the VAT period, the business should add up the VAT inclusive total of all supplies and apply the flat rate percentage to this gross total to give the amount of VAT due on those supplies.
Sales invoices should be issued to VAT registered customers. The customers will treat these as normal VAT invoices. The business must keep copies of all sales invoices issued to its VAT registered customers.
Input VAT Businesses on the flat rate scheme are unable to claim back any VAT on purchased goods and expenses used for the purposes of their trade. However, a business can reclaim the VAT it has been charged on a single purchase of capital expenditure goods where the amount of the purchase, including VAT, is £2,000 or more. If all the items are from one supplier at one time, then they count as one purchase of capital expenditure goods. If they are from three different suppliers or at three different times then they will be three purchases and each must be £2,000 or more (including VAT) to qualify for a reclaim of VAT.
Accounts preparation for businesses using the flat rate scheme Accounts for businesses using the scheme will be prepared using gross receipts, less the flat rate VAT percentage, for turnover and expenses will include the irrecoverable input VAT.
For both VAT and income tax purposes, there is a requirement to keep a record of sales and purchases. But, for businesses using the scheme, that record does not have to analyse gross, VAT and net separately. The records need only be complete, orderly and easy to follow.