VAT flat rate – is it still worth it?

Changes to the VAT flat rate scheme mean some small businesses should reassess whether the scheme remains suitable for them. The scheme simplifies the way in which small businesses calculate their VAT liability, and it can also result in VAT savings.

Under the flat rate scheme, VAT is calculated by applying a flat rate percentage to the VAT-inclusive turnover and most input VAT on purchases is ignored. However, from 1 April, a flat rate of 16.5% has been introduced for ‘limited cost businesses’ (LCBs).

With the normal basis, a business would pay VAT of £200 on turnover of £1,000. A flat rate of 16.5% results in a liability of £198 (£1,200 at 16.5%) – virtually the same. For an LCB with even a modest amount of input VAT, the flat rate scheme is no longer attractive. You are classed as an LCB if the amount of goods you purchase are less than either 2% of your turnover, or £1,000 a year (£250 a quarter).

Unfortunately, only goods count and these must be used exclusively for business purposes. There are numerous exclusions e.g. capital expenditure, promotional items, vehicle costs and food or drink for yourself or staff. Goods bought solely to meet the test are also excluded. Stationery, other office supplies, gas and electricity and cleaning products should count.

Defining your business
You have to determine your LCB classification for each quarterly or annual VAT period. So if your turnover or goods purchased fluctuate, you could find yourself alternating between the 16.5% rate and your normal trade percentage. If you are permanently classed as an LCB, you will probably want to leave the flat rate scheme.

You can still continue to use the cash accounting and annual accounting schemes even if the flat rate scheme is no longer beneficial for you. This is particularly useful if you give credit to customers, because VAT is not accounted for until you receive payment. You do not have to pay VAT on bad debts.

The advantage of the annual accounting scheme is mainly administrative savings, because only one return is submitted each year. This should help traders avoid incurring penalties for submitting late returns. There are various qualifying conditions, but generally your turnover must not exceed £1.35 million and you must be up to date with your VAT returns and payments. We are here to advise you.