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Introduction
What is the Flat Rate VAT scheme, and how does this work in practice? The HMRC Flat Rate VAT scheme (FRS VAT) was initially introduced by HM Revenue & Customs in 2002. However, what is Flat Rate VAT? VAT is one of your main contractor limited company taxes, if your business registers for VAT. Under Flat Rate VAT for IT contractors and other contracting professionals, your business will pay a lower rate of VAT to HMRC. This is when you compare it to what VAT you pay under the Standard VAT Scheme. Therefore, is it worth joining the contractor Flat Rate VAT scheme?
Ordinarily, under the VAT standard rate scheme, the amount of VAT that a business pays or claims back from HM Revenue and Customs (HMRC) is the difference between:
- The VAT that is charged by the business to customers; and
- The VAT the business pays on their purchases.
As mentioned, the VAT due to HMRC under the FRS scheme is less than under the standard scheme. However, let us now look into the Flat Rate VAT scheme rules and how this works.
Key features -the contractor Flat Rate VAT (UK) scheme
Some of the key features of the HMRC FRS scheme are:
- Simpler record keeping for your business. Under the Flat VAT Rate Scheme, your business will pay a fixed rate of VAT to HMRC.
- VAT savings for your business. Your company gets to keep the difference between a) what your business charges your customers and b) what it pays to HMRC.
- Flat Rate VAT -capital purchases. Under the scheme you cannot reclaim the VAT on your purchases. However, you can reclaim the VAT on certain capital expenditures that cost over £2,000.
The HMRC Flat Rate VAT scheme aimed to simplify paperwork for small businesses when accounting for VAT. Businesses who are under the Flat Rate VAT threshold of £150,000 (excluding VAT) in a financial year are eligible for the FRS scheme. Once a business joins the scheme, it will not have to leave until its VAT-inclusive annual turnover exceeds £230,000.
Joining and leaving the HMRC Flat Rate scheme
How to register for VAT Flat Rate scheme
You can join the contractor Flat Rate VAT (UK) scheme when you initially register for VAT. Alternatively, you can register for Flat Rate VAT when you are already VAT registered. You will apply to HMRC by completing form VAT600 FRS and either:
- Email it to [email protected].
- Send it by post to BT VAT, HM Revenue and Customs, BX9 1WR. Please use this address, rather than the address on the actual form.
You will receive confirmation that you have joined the scheme through:
- Your VAT online account (if applying online).
- Through the post (if you send the form through the post).
How to leave Flat Rate scheme
You can choose to leave the FRS scheme at any time. In addition, you must leave if you are no longer eligible to be in it.
When leaving the Flat Rate scheme, you must write to HMRC VAT Registrations. Their address is BT VAT, HM Revenue and Customs, BX9 1WR. Once they reply, they will confirm your leaving date.
After leaving the scheme, you must wait 12 months before applying to re-join.
How it works and Flat Rate VAT scheme percentages
FRS initial thoughts
Under the HMRC contractor Flat Rate VAT scheme, a business registered for VAT and operating under FRS will charge VAT on its goods and services using standard rate VAT at 20% (on the net value of work).
However, when calculating Flat Rate (in the past), it would pay over a lower percentage to HMRC. E.g., Flat Rate of VAT of 14.5% for the IT consultancy sector (now 16.5% -see below). In addition, you calculate the FRS VAT on the gross value of work. HMRC provide a list of Flat Rate VAT percentages. Therefore, You can search for your trade under the list of HMRC VAT Flat Rate scheme percentages. As a result, under this list you can find which rate you will pay under the scheme.
Besides paying over a lower VAT rate under the HMRC Flat Rate VAT scheme, the business cannot reclaim the input VAT on its costs. That is unless it is on certain capital assets costing £2K or more.
Therefore, in most cases previously, under the VAT Flat rate percentages available, the Flat Rate VAT (IT contractor) percentage would have been 14.5% of the gross sales.
When we look at how to calculate Flat Rate VAT (UK), completing the bookkeeping, and VAT return completion, under the FRS scheme this is very much simplified. The reason for this is that the business cannot reclaim the VAT on costs as mentioned above. Therefore, there is much less analysis work to do.
Our VAT guide covering VAT in more detail gives you a comprehensive insight into how VAT works.
FRS VAT scheme -limited cost business
In April 2017, the FRS scheme rules changed for those on, or wanting to join fixed rate VAT. As a result of the HMRC Flat Rate scheme changes, a new entity came into play. This is known as the `limited cost trader’ or `low-cost trader.’
If a business falls under the limited cost trader classification, the FRS scheme VAT percentage is a fixed rate of 16.5% on the gross value of work. Under these rules, in most cases the majority of your UK contractor business expenses will not be classed as relevant goods (see below).
What is a limited cost business or low-cost trader Flat Rate VAT?
HM Revenue & Customs (HMRC) defines these as those whose gross expenditure on relevant goods is either:
- Less than 2% of their VAT-inclusive turnover; or
- Greater than 2% of their VAT inclusive turnover but less than £1,000 annually.
Relevant goods
Under the HMRC Flat Rate VAT scheme guidelines, the relevant goods should not include:
- Any services which are anything but not goods.
- Expenses like travel and accommodation.
- Food and drink which is eaten by yourself or your staff.
- Vehicle costs, including fuel, unless you are in the transport business using your own or a leased vehicle.
- Rent, internet, phone bills, and accountancy fees.
- Gifts, promotional items and donations.
- Goods you will resell or hire out unless this is your primary business activity.
- Training and memberships.
- Capital items, including office equipment, laptops, mobile phones and tablets.
Therefore, most UK contractors will likely be’ limited-cost traders’ due to the types of services that they provide.
Flat Rate VAT vs standard VAT scheme
Let us now look at a contractor Flat Rate VAT example. We will consider what the previous and current gains if you are operating under the FRS scheme:
- Prior to the change in April 2017 -£10,000 monthly invoice + VAT (£2000) = £12,000 x 14.5% = £1,740.
£2,000 VAT charged – £1,740 FRS VAT = £260 gain per £10,000 invoiced to the customer.
- After the change in April 2017 -£10,000 monthly invoice + VAT (£2,000) = £12,000 x 16.5% = £1,980.
£2,000 VAT charged – £1,980 FRS VAT = £20 gain per £10,000 invoiced to the customer.
Therefore, the bookkeeping and Flat Rate scheme VAT return completion is simplified under the FRS scheme. However now, as shown in this Flat Rate example under the low cost trader Flat Rate VAT rules, for each £10,000 you invoice you only gain £20.
Flat Rate VAT for IT contractors and other independent contractors
When you are a limited company contractor you can choose whether you would like to register for the HMRC fixed rate VAT scheme. This is of course subject to your business falling under the threshold where you would not qualify for the scheme. The contractor Flat Rate VAT return itself is much easier to complete. In addition, there is less analytical work to do for each accounting period. As most limited company contractors will fall under the limited-cost trade bracket, the rate for contractor FRS VAT will be 16.5% of the gross invoice.
From the above, you can work out what you are gaining per month under the FRS scheme. You can then compare it against the VAT that you incur per month on your expenses (that you can claim under the VAT standard rate scheme).
For example, if you charge £8,000 per month pre-VAT for your work. £20 / £10,000 * £8,000 = £16 gain per month under the HMRC fixed rate VAT scheme. If the VAT on your accountancy fees, mobile phone bill, and other VAT-inclusive costs add up to £100, for example, then you would be better off by £84 (£100 – £16) per month by being under the standard VAT scheme as opposed to the FRS scheme. As VAT is one of your contractor taxes, operating under the standard VAT scheme is one of our handy tax tips for contractors and small business owners.
Final thoughts
When we consider FRS VAT for IT contractors, some still use this scheme. As we mention earlier, the contractor VAT Flat Rate scheme makes your VAT record keeping easier to maintain. However, this is no longer as beneficial financially. On the other hand, bookkeeping is not as straightforward under the standard VAT scheme because you must reclaim VAT on all your costs.
Since 2019, we are now in times of Making Tax Digital. Therefore, most businesses use online software such as FreeAgent, which helps calculate the VAT on costs. This also makes the analytical work much easier as it is computed on the digital software.
Finally, when using digital software, you only really need to know which costs include VAT (i.e., which receipts have UK VAT numbers on and are a VAT-inclusive cost) and then select the appropriate option for the VAT rate in the online software.
Link to Contractor Advice UK group on
