What is the VAT Flat Rate Scheme?
The Flat Rate Scheme (FRS) is an alternative way for a small business to account for VAT, the purpose of the scheme being that it reduces the administrative burden on small businesses by allowing them to keep simplified and less detailed VAT records.
The basic mechanics of the scheme are that, in return for giving up the right to claim VAT on it’s regular purchases, a small business declares VAT on the gross value of ALL their sales, including zero-rated and exempt sales, at a reduced percentage.
That rate is set by HMRC according to the business’s main business activity and may be subject to a further 1% reduction in the first year of VAT registration.
The scheme does however allow a business to claim VAT on larger value purchases of individual goods that are capital assets of the business.
A word of warning though.
Despite its purpose the use of the scheme may mean that a business receives the additional benefit of paying less VAT than if they were not using the scheme but it can also result in the opposite, with the business paying more VAT than if they were not using the scheme.
However, with effect from 1/4/2017 HMRC have introduced a mandatory test into the scheme to try to reduce the sometimes significant financial benefit some businesses have enjoyed in the past. Businesses that fail this mandatory test have to calculate the VAT due on their gross sales using a rate of 16.5% instead of their normal reduced rate percentage. HMRC have referred to such businesses as Limited or Low Cost Traders.
This additional test will obviously make use of FRS much less unattractive to some businesses so it is important to consider your businesses circumstances and whether they would likely be a Limited Cost Trader before deciding to opt for the scheme.
Flat Rate Scheme FAQs
Will I gain a financial benefit from using FRS?
It is not possible to say as each business’s specific circumstances will have an impact on this.
That said, a business that makes predominantly zero-rate or exempt supplies are less likely to find themselves with a financial benefit than a business that makes predominantly standard rate sales.
Am I eligible to use the FRS?
As long as:
- your taxable turnover in the next year is not expected to be more than £150000; AND
- You are not excluded under any of the exclusions listed in the HMRC VAT Notice 733 para 3.6.
What sales do I take into account when considering whether my taxable turnover will be more than £150000?
The VAT exclusive value of all taxable supplies (standard-rated, reduced rate and zero-rated supplies).
How do I apply to use FRS and when do I start using it if I apply?
Either apply online on www.gov.uk or download and complete form VAT600FRS, which can be downloaded from the same website (VAT Notice 733 Para 5.2 provide link). If the application is accepted HMRC will issue a letter confirming acceptance onto FRS and the effective date from which FRS is to be used.
How do I find out what FRS rate I should use under the FRS?
HMRC publish a list of rates, separated into trade sectors, within their guidance at FRS7200 and FRS7300. Use the trade sector closest to your main business activity but be careful to read them all before selecting the appropriate one as HMRC will not agree your choice at the time of application but could, at a later date, decide its wrong and if they consider the rate should have been higher they will want any additional VAT due.
What do I do if I have more than 1 business activity?
Select the rate for the trade sector that is closest to the business activity that provides the largest proportion of your turnover.
When does the 1% reduction to my FRS VAT rate apply?
The reduction only applies for the first year of VAT registration, not the first year of using the scheme. If you join the scheme part way through your first year of VAT registration the 1% reduction will still apply for the remainder of your first year of registration.
Can I claim VAT that was incurred prior to VAT registration even if I am using FRS from my date of registration?
Yes. The restriction on claiming VAT while using the scheme only applies to purchases made after while using the scheme. VAT incurred on purchase of goods and services prior to VAT registration can be claimed under the normal rules governing pre-registration recovery of VAT.
Can I claim VAT on any purchases made while using FRS?
Yes but only in regards to a single purchase of capital goods of £2000 or more. This can be of a single item or a number of associated items which are purchased from the same supplier, at the same time and are charged to you on the same invoice.
Can I claim VAT I incur on services?
No, even if the cost of those services is £2000 or more.
Do I still need to issue VAT Invoices?
Yes. You should raise an invoice charging VAT to your customer at the VAT rate that would normally be charged on your supply if you were not using FRS.
How do I calculate the VAT due to be declared on my sales?
Calculate the total gross value all your sales in the VAT period, including exempt sales and sales of goods to business or private customers in the EC and then multiply this figure by your FRS rate.
When do I have to leave the scheme?
At each anniversary of your joining FRS you must review your turnover (again including VAT as well as all exempt and EC Sales) for the previous year and must leave the scheme if:
- Your turnover in that year exceeded £230000; or
- your business is growing rapidly and you have reason to believe that your total income in the following 30 days will be more than £230000; or
- your circumstances change and that change means that you are now excluded from using FRS under the guidance given by HMRC in VAT Notice 733 para 3.6.
What is the mandatory test for Limited or Low Cost Trader?
If your gross expenditure on relevant goods is either less than 2% of your FRS turnover in your VAT period or is less than £1000 for annual VAT period (£250 if your VAT period is a normal quarterly VAT or £83.33 if your VAT period is a monthly VAT period) then you will be a Limited or Low Cost Trader and will be forced to use the 16.5% rate.
Do all FRS users have to do this mandatory test?
Technically, yes, although if you buy and sell goods as your main business activity, for example if you are a retailer, manufacturer or restaurant, you are much less likely to fail the test than if your main business activity involves you providing services and you have little or no expenditure on goods.
What are relevant goods?
There is no definitive list of what are considered to be relevant goods, although HMRC provides some guidance within para 4.6 of HMRC VAT Notice 733.
However, we have had numerous queries in regards to “relevant goods” so here is some basic guidance as to what are not “relevant goods”, based upon queries that have already been asked of us:
- The supply of any type of service can never be a supply of “relevant goods”.
- Only goods purchased exclusively for your main business activity may be considered “relevant goods”.
- Goods that will put to both business and private use are not “relevant goods”.
- The hire or rent of goods or property is a supply of services.
- Purchases of assets of any value are excluded from being “relevant goods”.
- Promotional items to be given away are excluded from being “relevant goods”.
- The supply of anything electronically or as a download is a supply of services.
- Wages are not “relevant goods”.
- Fuel for a car or van is not “relevant goods” unless your main business activity is within the transport industry (ie hauliers, couriers, passenger transport businesses). If you transport your own goods, such as tools in a van or make delivery of goods you are selling you are not in the transport industry.
- Supplies by subcontractor are services but if they also supply goods as part of their supply of services the goods are “relevant goods” as long as they are separately itemised and valued on the supplier’s invoice.
Current HMRC guidance is provided on www.gov.uk in
VAT Notice – 733
HMRC Manuals – VAT Schemes – Flat Rate Scheme
This guide was provided by Qdos Vantage – Specialist Fee Protection providers.
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If you are in business, whether as an individual, a partnership or as a Limited Company, then you must register for VAT once your taxable turnover reaches a certain threshold. If you do not register for VAT at the right time you could be subject to penalties.
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