Cross the £90,000 VAT threshold and you have a decision to make. Stay on standard VAT and reclaim input VAT on your purchases, or move to the Flat Rate Scheme and pay a fixed percentage of your turnover. We get asked which one to pick almost every time a client registers for VAT. The honest answer is: it depends on your industry, your spending pattern, and how much admin you are willing to deal with. Here is the maths you actually need to do.
How Standard VAT Works
Under standard VAT you charge 20% on your sales and reclaim 20% on most business purchases. The difference is what you pay HMRC each quarter. The scheme rewards businesses with significant VAT-rated expenses because every pound spent on a qualifying business cost reduces your VAT bill by 20p. It also requires careful record keeping because every invoice needs to be retained and reconciled.
How the Flat Rate Scheme Works
Under the Flat Rate Scheme (FRS) you still charge 20% VAT on your sales, but you pay HMRC a fixed lower percentage of your gross turnover (sales including VAT). The percentage depends on your industry sector. You cannot reclaim input VAT on purchases except for capital assets costing more than £2,000. Simpler to operate, but only works for businesses with low VAT-rated spending. To join, your turnover needs to be under £150,000. You can stay in the scheme until you hit £230,000.
The Limited Cost Trader Rule That Kills Most Service Businesses
HMRC introduced the Limited Cost Trader rules in 2017 specifically to stop service businesses with low expenses from cleaning up on the Flat Rate Scheme. If your spending on VAT-rated goods is less than 2% of your turnover, or less than £1,000 a year, you are a Limited Cost Trader and pay a flat rate of 16.5%. At that rate, the scheme almost always costs more than standard VAT. For most consultancies, agencies and contractors, the Flat Rate Scheme stopped making sense the day this rule came in.
When the Flat Rate Scheme Actually Wins
The scheme works best for businesses with high turnover and meaningful VAT-rated spending that lifts them clear of Limited Cost Trader status. Some trades, certain product-heavy professional services, and any business with regular VAT-rated goods purchases can come out ahead. The first-year discount of 1% off your flat rate is another nudge. Run the numbers on your last 12 months of actual figures before committing.
Cash Accounting and Annual Accounting
Both standard VAT and the Flat Rate Scheme can be combined with cash accounting (you pay VAT when you actually get paid, not when you invoice) and annual accounting (one return a year with monthly payments on account). For businesses with slow-paying customers, cash accounting on its own can be worth more than switching schemes.
Speak to a Business Strategy Accountant Today
Run the numbers both ways using your actual turnover and expense profile. The Flat Rate Scheme looks attractive on the surface for many service businesses but loses its edge under the Limited Cost Trader rule. A specialist VAT accountant models both scenarios and recommends the option that saves you the most, including the option to switch schemes as the business changes.
