Normally, the business will pay (or reclaim) VAT to HMRC based on the difference between the VAT that is charged to the clients and the VAT suffered on the purchases.
The flat rate scheme is an incentive offered by HMRC to small businesses, helping them simplify the process.
The business will charge VAT as normal (currently 20%) on its invoices, but pay less VAT back to HMRC, i.e. VAT at a lower rate. This lower rate depends on the profession/trade of the business (list available on HMRC website) and is calculated against the total income of the business (including VAT) for the VAT quarter.
The business will however not be able to claim any VAT on its purchases and expenses, with the exception of capital purchases costing over £2,000 (e.g. equipment and machinery). The cost for the capital purchase must exceed £2,000 on one invoice for it to be claimable i.e. you cannot claim VAT where you buy a PC and a printer on separate invoices, even though overall it exceeds £2,000.
It is important to note that the client will still be charged VAT as normal, but it is only when the VAT return is being prepared, that we perform the flat rate calculations.
The scheme is available to those businesses with less than £150,000 annual turnover (excluding VAT). Upon joining the scheme, a business will need to come off the scheme once the annual turnover exceeds £230,000 (including VAT).
ADVANTAGES
• The business does not have to maintain onerous VAT records for purchases/expenses – however receipts still need to be kept for business tax purposes.
• For businesses registering for VAT for the first time, HMRC also offers a discounted VAT rate of 1% for the first year.
This scheme is usually advantageous for contractors, freelancers and consultants – but in some circumstances may be suitable for other types of businesses also.
Example for IT contractor:
Amount invoiced to client (excluding VAT) = £10,000
VAT charged to client @ 20% = £2,000
Gross Amount receivable from client = £12,000
Flat rate VAT (including 1% discount) 13.5%
VAT Paid to HMRC = £1,620
VAT received from the client = £2,000
Profit kept by business = £380
DISADVANTAGES
The scheme may not be beneficial in the following circumstances:
• Where the business has large amounts of VAT on purchases that will otherwise then not be claimable
• Where the business also generates other income that is normally not vatable. For example any rental income (usually exempt) will also be subject to the flat rate VAT.
Contact us for further enquiries and we’ll be happy to help.