How to make money and pay less VAT

Yes it is true, depending on the type of business you are in you could make money from being registered for VAT and in turn pay less VAT over to the VAT man. It’s all to do with the Flat Rate VAT Scheme.

In the UK if your turnover for the previous 12 months is more than the current registration threshold of £85,000 then it is likely that you will be or need to be registered for VAT. There are exceptions to this rule but to keep things simple this is the basic rule to adhere to.

If you are already registered for VAT you will already be familiar with the quarterly requirement to prepare a VAT return and pay any VAT liability over to HMRC.  Usually when a business is registered for VAT they complete VAT returns on either an accruals (invoice) or cash basis, each of which have their benefits and drawbacks.

There are other VAT schemes applicable to certain businesses and one of these is the Flat Rate VAT Scheme.

What is the Flat Rate VAT Scheme?

The Flat Rate VAT scheme is designed to make bookkeeping easier for small businesses by applying a flat rate percentage to your total sales, rather than working out the VAT on sales made and deducting VAT that can be reclaimed on purchases made.

A quarterly VAT return still needs to be completed and a VAT liability and payment will still be made again on a quarterly basis.

The criteria for acceptance and remaining on the Flat Rate Scheme is as follows:

  1. If you estimated annual turnover excluding VAT will exceed £150,000 in your first year, you shouldn’t join the scheme.
  2. If your annual turnover exceeds £230,000 of VAT inclusive revenue in subsequent years you must leave off the scheme.
  3. If you are on the flat rate scheme you are unable to claim back any VAT on purchase made the business. You can however reclaim VAT on assets purchased over £2,000.

How does the Flat Rate VAT Scheme (FRS) work?

You will need to charge the standard VAT rate, currently 20%, on your invoices, just as you would do normally.  The difference being that rather than accounting for the VAT on every payment, when you do your quarterly report you will only pay a single flat rate percentage on your turnover of each quarter.

There is no need to calculate VAT to reclaim on purchases nor do you need to calculate VAT on each sale made,  just simply total up all the sales made during the quarter (inclusive of VAT) and apply the appropriate VAT % depending on your business.

*Please keep in mind the limited cost trader category restriction. See below.

Pay less VAT

The Flat Rate VAT Scheme works best for those type of businesses that provide services as generally speaking they will not recover much in the way of input VAT as they have no costs such as buying materials/products.

Will it save me money?

HMRC designed the scheme to reduce the administration side of VAT and make record keeping easier rather than save money.  Percentages are set based on the amount of VAT a business would typically reclaim in its sector but some businesses can save money by using the scheme.

This is especially true for service based businesses where normal amounts of VAT reclaimed on purchases is low.

The scheme has an added benefit in that for the first year on the scheme a 1% reduction in the appropriate percentage can be applied, increasing any potential saving further.


For an IT contractor the first year rate is set at 13.5%.  Based on a £400 day rate the saving would be as follows:

Based on a 5 day working week, 48 weeks per year.

£400 x 5 x 48 = £96,000 (per annum) / £24,000 (per quarter)

VAT @ 20% = £19,200 (per annum) / £4,800 (per quarter)

Flat Rate VAT @ 13.5% (first year) on total sales plus VAT (£96,000 + £19,200) = £115,200 x 13.5% = £15,552 (per annum) / £3,888 (per quarter)

A potential saving on VAT and therefore less VAT to pay of £3,648 (per annum) / £912 (per quarter). The amount of purchases that your business would typically have of which VAT can be reclaimed will need to be considered as the more purchases the lower the potential saving.

To find out what percentage that would apply to your business see the HMRC Flat Rate Scheme page.

What is a limited cost trader?

In April 2017, a new category was introduced for a ‘limited cost business’ within the flat rate scheme. This was introduced to tack aggressive abuse of the VAT Flat Rate Scheme.

Firstly it is worth noting the key points:

  • Cost and time-saving advantages must be weighed against not claiming input tax.
  • Some categories remain worth considering.

The ‘new’ 16.5% rate applies to users that spend either less than 2% of their gross sales on goods or £250 in a VAT quarter.

Top five Potential Flat Rate winners

  • Advertising – 11%. If an advertising business has enough spending on goods to keep out of the limited cost trader category and does not have much input tax on its other spending, 11% is a good rate for any service business.
  • Computer repair services- 10.5% . The same logic applies as above.
  • Entertainment or Journalism- 12.5%. A consideration here may be for journalists to buy hard copy books rather than online publications for research. As the books are zero rates, no loss of input tax and the spending will help reach the £250/2% limit for spending on goods to avoid the limited cost trader category.
  • Hotel or accommodation- 10.5%. FRS might be good for a small bed & breakfast business but keep in mind, as soon as a big repair bill or improvements are made, the gains could be wiped out.
  • Repairing vehicles- 8.5%. Despite the favourable percentage, it is imperative all aspects are considered. If for example the landlord opted to tax the building and therefore the rent for the garage is standard rated rather than exempt, the scheme is a non-starter.