In addition to the usual method of accounting for VAT, where you add 20% onto sales, pay this to HM Revenue and Customs (HMRC) and claim back the VAT on your purchases, there are other methods you can use.
There are three main methods for calculating VAT; the flat rate scheme, the cash accounting scheme and the annual accounting scheme.
The most popular of these is the flat rate scheme (FRS). This method involves accounting for VAT at a lower percentage of your sales, meaning you have less VAT to pay each quarter to HMRC. However, you will not be able to claim back VAT on most expenses.
Calculating VAT due using the Flat Rate Scheme
The percentage you use depends on the type of business you have, you can find a list of the different percentages for businesses by clicking here.
Calculating the VAT amount from this percentage is a bit more complicated than it is for standard VAT. First you take your net sales amount and just like with standard VAT you add 20% onto it, for example, £100 becomes £120, which would be applied to your invoices just like normal VAT.
You then apply your FRS percentage to the gross figure, so if you have an FRS percentage of 10% the VAT you would need to pay in the above example is £12. You would also just calculate this percentage for your total sales income for the quarter instead of working it out for each individual invoice.
This is the most confusing aspect of the FRS, as standard rate VAT is 20% of the net figure but as you can see above an FRS percentage of 10% is 12% of the net figure. Make sure you remember to use the gross figure to calculate your amounts for FRS or you could find yourself missing out on some of the VAT. This could build-up to a large amount due or even have interest/penalties charged if HMRC discovers it before you resolve the additional VAT.
Claiming back VAT with the Flat Rate Scheme
As mentioned above you normally cannot claim back VAT on your purchases, however, if you purchase a capital item for the business, such as a van or large tools, you can claim back the total VAT for it if the invoice total is £2,000 or greater. This includes several capital items on the same invoice that add up to £2,000. For example, if you are buying tools for the business and are using the FRS to calculate VAT, make sure you try and buy them together so you can claim back the VAT.
First-year of a VAT discount
It makes sense to see if you are better off with normal or FRS VAT early on because you are allowed to calculate your FRS VAT at 1% less for the first year of your business being registered for VAT. This means if you have an FRS percentage of 10% but have been registered for VAT for 6 months, you can use an FRS percentage of 9% for the next 6 months.
Advantages of the Flat Rate Scheme
The main advantage of the FRS is that it simplifies the VAT return and bookkeeping processes. FRS users no longer need to analyse out the VAT on expenses and sales. Instead, they just have to multiply their gross sales figure by the flat rate percentage to get the VAT due.
There may also be an advantage financially if the effect of the reduced VAT percentage outweighs the effect of no longer claiming back VAT on expenses.
Disadvantages of the Flat Rate Scheme
If you regularly claim back a lot of VAT on expenses, you won’t be able to claim any of it back on the FRS (with the exception above for tools) which could have a negative effect on cash flow.
You will also find the FRS unsuitable if you make zero-rated or exempt sales where the amount of actual VAT is likely to increase, in addition to not being able to claim back for VAT purchases.
Joining the Flat Rate Scheme
To join the FRS you will need to download and send this form to HMRC.
If your VAT taxable turnover is over £150,000 per year however, you will be unable to use the flat rate scheme for calculating your VAT.
You will also be unable to join if you were in the scheme within the last twelve months, closely associated with another business, such as being eligible to join a VAT group or registered as a division of a larger business in the past twenty-four months.
Businesses that have suffered a conviction for a VAT offence or a penalty for VAT evasion will also not be able to use the FRS.
Leaving the Flat Rate Scheme
You can leave the FRS by sending a letter to HMRC who will then confirm the date you may leave the scheme. Once you leave the scheme you will need to wait twelve months before you can rejoin. The address to write to is:
HM Revenue and Customs
77 Victoria Street
Limited cost traders
Previously, if you claimed next to nothing for expenses VAT wise, you would get a very generous saving depending on the percentage you used. As the point of the FRS is to simplify VAT rather than reduce it, HMRC have introduced a new percentage category known as limited cost traders (LCTs).
LCTs are businesses where the VAT inclusive expenses are unusually low at less than 2% of the VAT inclusive turnover or if greater than 2% and less than £1,000 for a twelve-month period (the £1,000 will be apportioned for less than twelve-month periods).
Capital expenditure such as assets, motor expenses and food or drink to be consumed by the business or employees are not counted when calculating the VAT inclusive expenses. This is to prevent a business from making quick purchases to avoid being an LCT.
a LCT has a flat rate percentage of 16.5%, which if applied to gross sales figures, equates to roughly 20% of the net figure. This means you effectively pay standard rate VAT but cannot claim back any VAT on expenses (which should be low anyway).
LCTs will take effect from the 1st of April 2017, therefore if you feel you may be subject to the above percentage, please be sure to check in order to avoid a penalty for using the wrong VAT percentage.
Using the Flat Rate Scheme with other accounting schemes
You cannot use FRS with the cash accounting scheme, however, it is possible to use the FRS with the annual accounting scheme providing you are eligible to use both schemes. You can even apply to use both schemes at the same time using this form.
If you are already using the FRS you can use this form to join the annual accounting scheme.
If you would like any advice or assistance with the above, or help in deciding if the flat rate scheme is right for your business then please do not hesitate to contact us.