Benefits of the VAT Flat Rate Scheme

HMRC offers a few different VAT schemes designed to make compliance easier. The Flat Rate Scheme (“FRS”) is great for businesses that have few expenses so are able to convert a large amount of sales to profit. It’s absolutely perfect for contractors with a decent day rate and only travel expenses as costs.

First let’s just recap a standard VAT set up. You add VAT onto the value of your net sales and set aside that money to give to HMRC. On the purchases you make you have to pay the seller VAT on top of the net cost and you then claim that back from HMRC.

So, the flat rate scheme. First forget about purchases because you won’t be able to claim back VAT on any purchases*. That sounds bad but bear with me. On the sales you still charge 20% to your customers. So if you sell a service for £100 + VAT the client will pay you £120. But when you come to work out how much money you owe HMRC you don’t pay them 20% of your sales you pay a percentage based on your industry (see below). This means that if, like me, you are an accountant you will only pay £17.40 to HMRC even though you collected £20 from your client. A small saving but if you are talking about sales of £60,000 (net) then the difference would be £1,560.

* With the exception of some capital assets that cost greater than £2,000

Here is a link to the HMRC site with a full list, but below are a few that might apply to you:

Taking the example of a freelance web designer (using the 11% Advertising rate). This web designer typically bills clients £40,000 per year (excl VAT) but only has expenses of about £5,000 per year (excl VAT).

Under the standard VAT scheme he would owe HMRC £8,000 (40,000 x 0.2) per year on his sales offset by £1,000 (£5,000 x 0.2) of purchases. A net payment of £7,000. Remember there is no ‘loss’ here and no ‘profit’ either. Everyone is just collecting cash on behalf of HMRC.

Under the Flat Rate Scheme the web designer would have a rate of 11% of sales. So he will pay £5,280 (48,000 x 0.11). That’s it. The web designer has effectively just made £1,720 (£7,000 – £5,280) of profit by registering for the flat rate scheme.

Whether it will be beneficial or not comes down to the proportion of expenses to sales. Sticking with the £40,000 of sales, it will still be beneficial until the VAT that would be recoverable exceeds £5,200 (ie, the value of VAT-able expenses exceeds £14,000) or if you prefer percentages when the expenses exceed 35% of sales.

As HMRC calculate average levels of profitability when coming up with their rates it means that if you are more profitable than your industry average you will tend to benefit.

Have a look at your most recent few tax returns if you currently use the standard VAT scheme.

Take your gross sales for your last VAT quarter and multiply it by your relevant industry FRS percentage, compare the result to box 5 on your last VAT return. If your calculation is less you would have saved money using FRS in that quarter.