How the Flat Rate Scheme for VAT can add to your profits (Part 1)

VAT - FRS part 1 (cropped) (cropped)

Most VAT registered businesses use Standard Accounting for VAT but if your VATable turnover is £150,000 or less, joining the Flat Rate Scheme may be beneficial to your business and you could end up with 'extra income'.

Overview of the scheme
With the VAT Flat Rate Scheme, you don’t reclaim VAT on your purchases (see below for exceptions to this)

You only submit information about the VAT charged on your sales. You:

  1.  Pay a fixed rate of VAT on your GROSS sales (Net sale + VAT) and
  2.  Keep the difference between the VAT you charge your customers and the amount you pay to HMRC.
The difference is considered to be income and therefore, you will have to pay tax on it, unless it is spent on allowable business expenses. 

Fixed rate of VAT
Once you have identified the percentage rate that is appropriate for your business, use it to work out how much VAT you need to pay HMRC.

However, there are two scenarios where the rate to use may be different:

  1. If you are a limited cost business. (see follow up blog for more details)
  2. If you are in the first year of VAT registration, you can reduce the rate by 1% from the date of first registration to the day before the first anniversary.
A mechanic has been VAT registered for more than a year and has identified that their fixed rate percentage is 8.5%.

Remember, the flat rate percentage is applied to the GROSS sale.

They charge £1,000 + VAT to their customer, therefore the total GROSS sale is £1,200.

Applying the fixed rate percentage to the GROSS sale. they owe HMRC £102 on this sale. The calculation is:

£1,200 (gross sale) x 0.085 (8.5% fixed rate percentage) = £102

Working out the difference between what they charge and what they pay to HMRC

The calculation is as follows:

VAT charged to customer
Minus fixed rate VAT owed to HMRC        (£102)
Difference shown as ‘extra income’            £  98 

In this example, the mechanic keeps the £98. Remember, this is considered to be income and therefore they will have to pay tax on it, unless they use it to pay for allowable business expenses.

Exceptions to the rule on reclaiming VAT on the flat rate scheme.
As mentioned earlier, if you are on this scheme, you don’t reclaim VAT on your purchases.

However, the exception is if you make:

  1.  A single purchase where the amount you pay, including VAT is £2,000 or more.
  2. What you purchase is considered to be Capital goods
For example. if you buy a computer package (computer, printer, camera, scanner, speakers etc) as ONE package and including VAT, the amount you pay is more than £2,000. The VAT paid on this purchase can be reclaimed.

There is a useful tool on The SAS Business Box which helps you decide if switching to the Flat Rate Scheme would be beneficial for your business.  It's free to explore!

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