The VAT flat rate scheme (FRS) is designed to simplify record-keeping and VAT calculations for small businesses. The scheme is open to businesses that meet both of the following criteria:
The taxable turnover (excluding VAT) for the next year will be £150K or less
The total business income (including VAT) for the next year will be £187.5K or less
For the FRS, you calculate your output VAT (the VAT you charge to your customers on your invoices) in the normal manner. To calculate your input VAT (the amount you off-set against your output VAT to calculate the VAT payable to HMRC), you simply apply a fixed-rate based on your trade sector and multiply it by your taxable turnover (including VAT).
Example: for a company which invoices its customers a total of £5K/month (excluding VAT) for a quarter in a trade sector with a fixed rate of 12%:
- Income Excluding VAT: 3 x £5K = £15K
- Output VAT @ 17.5%: £15K x 0.175 = £2,625
- Income Including VAT: £15K + £2,625 = £17,625
- Tax Payable to HMRC: £17,625 x 0.12 = £2,115
You can see that the calculation takes a couple of minutes and saves all the hassle of going through all your receipts individually and working out how much VAT you have paid (which is how it works on the full VAT scheme).
On top of all this, if you are in your first year of VAT registration, you are entitled to a 1% reduction in the flat-rate you pay.
You still need to collect receipts for your expenses for calculation of your Corporation Tax at the end of your comapny tax year, but you do not need VAT receipts.
The flat rate percentages used to calculate your tax payable are available from the Inland Revenue web site. The table is not that comprehensive as far as trade sectors goes, but they have a supplementary table to clarify matters because of the number of queries they had. Personally, I don't know why they didn't just update the main table and make everyone's life a lot easier.
Before you rush to sign up to the FRS, you should know that some companies will pay more tax under the FRS.
- The fixed rate percentages are based on the average expenses for that trade sector. By my reckoning, that means about half the companies in the trade sector will be worse off to some extent by using the fixed rate. If you are VAT registered using one of the other schemes (or if your company records are good enough for you to get hold of the figures), you should do a comparison to see if you will be better off. If you are just starting up in business, then talk to your accountant. If your are thinking of VAT registration, it may be worthwhile signing up to the FRS for a time while you get your business established as there is less effort involved.
- Companies who sell goods and services to other EU member states may pay more VAT under this scheme if they proportion of their business with EU member states is higher than the average for their trade sector.
I am just coming to the end of my second year using the FRS and I have had no problems with it. Due to a change in the balance of my work, I have just notified HMRC that I will be changing the flat-rate percentage I will be using and all that took was an e-mail. Anyone considering changing their flat-rate percentage should know that (unless there was a mistake and you are in the wrong trade sector) you can only change your flat-rate at the beginning of the quarter where your anniversary of starting the scheme falls. If you believe that you were put in the incorrect trade sector, then you can notify HMRC and see what they say; you should know that they will reclaim VAT if they believe you have underpaid, but you cannot get a refund if you have overpaid.