VAT Flat Rate Scheme (FRS) – could it help you save money?
What is the VAT Flat Rate Scheme (FRS)?
The Flat Rate Scheme is a simplified VAT scheme introduced to make life easier for VAT registered businesses.
Normally when you’re VAT registered you charge VAT to your customers (‘output VAT’) and pay VAT to your suppliers when you buy goods or services from them (input VAT).
When you prepare your VAT return and pay VAT to HMRC, you add up all the VAT you’ve charged, deduct the VAT you can reclaim and pay over the difference to HMRC.
However, when you use the Flat Rate Scheme (‘FRS’) you simply add up all your sales (including exempt sales), plus any VAT you’ve charged to your customers, and apply a fixed percentage to those sales (this can be anything from 6.5% to 14.5%) - and during your first year in the scheme you get a 1% discount of those rates.
You then pay this sum over to the VAT man.
This can be a much easier way for you to account for VAT - especially if you don't have much in the way of VATable expenses.
And you can also join the scheme if your turnover is below the normal VAT thresholds - which can be great for you if your customers base are mainly VAT registered (and, as above, you don't have much in the way of VATable expenses).
Example
As an example, for IT Contractors the rate in the first year is just 13.5%** of the gross amount and 14.5%** in subsequent years (you receive a 1% discount in your first year).
** Rates correct as at 31st May 2016 – for up to date rates go here.
So assuming Joe Bloggs, an IT contractor, charges £600 per day for a five day week and works 45 weeks a year, his VATable turnover will be £135,000 and his total turnover (including VAT of £27,000) will be £162,000.
So what will that look like... | |
|---|---|
Net Income | £135,000 |
VAT @ 20% | £27,000 |
Total Sales Invoice Value | £162,000 |
| |
FRS due to VAT @ 13.5% | £21,870 |
Gain from using FRS (£27,000 - £21,870) | £5,130 |
However, it’s important to note that this is the maximum saving possible. If Jo had VATable expenses that he could have offset against the £27,000 output tax bill, then the saving would have been lower.
Businesses on the flat rate scheme are unable to claim back most of the VAT on purchased goods and expenses for their business.
However you can still reclaim VAT on capital asset purchases over £2,000 (including VAT) – so for example you can claim the VAT back if you buy a lovely Apple iMac for £3,000. You can also claim the VAT on multiple capital purchases if these come to more than £2,000 and are all on the same receipt. You cannot however buy a PC one month for £1,500 then a printer the next month for £300 and a scanner the month after for £200 and add them together - they must all be on the same receipt.
Who qualifies?
To join the scheme you have to meet the following criteria:
• You expect your total VAT taxable sales* for the next year to be less than £150,000** excluding VAT
• You’re a VAT registered business
* All sales that are subject to VAT – which includes zero-rated sales but excludes exempt sales, sales outside the scope of VAT and sales of capital assets
** Rates correct as at 31st May 2016 – for up to date rates go here.
Once you join the scheme you can stay in the scheme until either:
• Your annual VAT inclusive turnover exceeds £230,000** - or you expect it to in the next 12 months
• You expect your total VAT inclusive income in the next 30 days alone to be more than £230,000
However, just because your turnover is within the prescribed limits (see above) doesn’t automatically mean your business qualifies to join the scheme.
In addition to the turnover test HMRC won’t let you join if any one of the following apply to your business:
• If you’ve already been in the scheme previously and left it less than 12 months ago you’ll have to wait until a year has passed until you can re-join.
• If you’ve been guilty of a VAT offence or charged a penalty for evading VAT within the last 12 months (hopefully this doesn’t apply to your business!).
• If you use the VAT second-hand margin scheme (where you only pay VAT on the difference between what you buy and sell an item for).
• If you are, or have been within the last 24 months, a member or potential member of a VAT group, or are registered for VAT as a division of a larger business,
• If your business is closely associated with another business. For example this may apply where a husband and wife run separate but similar businesses from shared premises.
Joining the scheme
Once you’ve determined that your business is eligible to join the scheme it’s then a question of determining what VAT rate to apply to your sales.
This will all depend on what business sector you work in.
You can see the full list of up to date sectors and rates here.
(And remember, you’ll get a discount of 1% of these rates in your first year in the scheme.)
If you’re confused as to which category your business falls in, there’s no point asking HMRC – they’re not allowed to give you any advice on this. You should therefore choose the sector that best describes your main business activity.
If you work in more than one business sector, you must use the one that represents the greater part of your turnover. You then apply that percentage to your total turnover.
If it is still unclear then you may wish to ‘play safe’ and choose the category with the highest rate.
HMRC and the tribunals will allow businesses to rectify genuine errors, but take a dim view if you try to opt for a more advantageous category when it’s obvious this is the wrong category for your business!
Once you’ve decided which rate is most appropriate you can then either apply online or in writing to join the scheme.
There’s more guidance from HMRC here as to how to join the scheme.
Tip
Make a written note to confirm why you have made your choice to apply a particular percentage to your business turnover. You will then have more chance of demonstrating that you made a ‘reasonable choice’ with your chosen category. This should help limit any potential HMRC challenge to future VAT periods and not retrospectively.
It is not unusual for HMRC to challenge a FRS decision many years later, particularly where there is a lot of VAT at stake (The Chilly Wizard Ice Cream Co Ltd being an example – yes really!).
Leaving the scheme
When it comes to leaving the FRS, the good news is that the threshold is higher than for joining.
You will need to leave the scheme if your previous twelve months turnover has exceeded £230,000** (including VAT) – and this only needs to be considered once a year on the anniversary date when your business first joined the scheme.
However the exit threshold is based on total income so you must also include all sales even if these are exempt or zero rated.
And if you have any questions, or would like any help on any other topics, feel free to email me at [email protected].