VAT Flat Rate Scheme vs Standard VAT: Which Suits Your Business?

Once your business is VAT registered, you choose how to account for VAT. Most businesses use standard VAT accounting. Some qualify for the Flat Rate Scheme, which is simpler but is not always cheaper. Here is how the two compare, and what to check before you decide.

Key takeaways

• Under standard VAT you pay HMRC the VAT you charge, minus the VAT you can reclaim on purchases.
• Under the Flat Rate Scheme you pay a fixed percentage of your VAT-inclusive turnover and usually cannot reclaim most purchase VAT.
• The scheme suits businesses with few VAT-able costs. It can cost more if you buy a lot.
• Limited cost traders pay a higher flat rate, which can cancel out the benefit.

How standard VAT works

With standard VAT accounting, you charge VAT on your sales. You also pay VAT on many of your purchases. Each return, you work out the difference: VAT charged on sales, minus VAT you can reclaim on purchases. You pay that amount to HMRC. If you have bought lots of equipment, stock or supplies, this can be a small bill or even a refund.

How the Flat Rate Scheme works

With the Flat Rate Scheme, you still charge your customers the normal VAT rate. But you pay HMRC a fixed percentage of your total VAT-inclusive turnover. That percentage depends on your type of business, and HMRC publishes the list. You usually do not reclaim VAT on most purchases. The trade-off is less record keeping in exchange for giving up most purchase VAT reclaims. Read the current rules on GOV.UK's VAT Flat Rate Scheme guidance.

Side by side

Worked example (illustrative)

"Omar", an illustrative example, runs a consultancy with almost no VAT-able costs. Because he has little purchase VAT to reclaim, the Flat Rate Scheme could cost him about the same as standard VAT, with far less admin. Now compare "Priya", another illustrative example, who sells goods and buys a lot of stock with VAT. Under standard VAT she reclaims that VAT each return. Under the flat rate she would give most of it up, so she could pay more. The right choice depends on your own numbers, not on which scheme sounds simpler.

Watch out for the limited cost trader rule

If your business spends very little on VAT-able goods, HMRC treats you as a limited cost trader and applies a higher flat rate. For many service businesses this removes the advantage of the scheme. Always test whether you would be a limited cost trader before you apply. Check the current rate and test on GOV.UK.

Common mistakes

• Choosing on simplicity alone. Run the numbers both ways first.
• Ignoring the limited cost trader rule. It can make the scheme more expensive than standard VAT.
• Forgetting to review each year. A change in your costs can change which scheme is cheaper.

Not sure which fits your business? Our VAT returns service can compare both for you. Good records make either scheme easier, so see also our guide to bookkeeping vs doing it yourself.