Flat rate scheme (FRS) for VAT

July 21st, 2020

The VAT flat rate scheme (FRS) is used by many small businesses to help simplify their VAT reporting obligations, although some VAT experts would argue that the scheme is not simple to use.

Broadly, the FRS is a simplified VAT accounting scheme for small businesses, which allows users to calculate VAT using a flat rate percentage by reference to their particular trade sector. When using the FRS, the business ignores VAT incurred on purchases when reporting VAT payable, with the exception of capital items which cost £2,000 or more.

If the business incurs few expenses, and it operates in a sector with a relatively low FRS percentage, it will pay out less VAT to HMRC under the FRS than it would outside the scheme. Historically, many businesses have registered for VAT voluntarily before their turnover reached the VAT registration threshold, so they could make use of the cash advantage offered under the FRS.

Most VAT-registered business can use the FRS if it is expected that VAT taxable turnover in the next 12 months to be £150,000 or less. Certain other eligibility criteria apply.

The business must leave the scheme if:

The VAT flat rate used usually depends on the business type.

Common percentages used by service-related businesses in recent years include:

 A 1% discount on the relevant flat rate is given in the first year as a VAT-registered business.

Since 1 April 2017, a flat 6.5% FRS rate has applied for businesses with limited costs (see below). Since the rate of 16.5% of gross turnover equates to 19.8% of the net, the result is that there will be almost no credit for VAT incurred on purchases.

A ‘limited cost’ business is defined as one whose VAT inclusive expenditure on goods is either:

‘Goods’ for these purposes must be used exclusively for the purpose of the business but exclude the following items:

(These exclusions are part of the test to prevent traders buying either low value everyday items or one-off purchases in order to inflate their costs beyond 2%.)

FRS and MTD

With regards to record-keeping, HMRC confirm that for compliance with Making Tax Digital (MTD) for VAT obligations businesses using the FRS do not need to keep a digital record of:

Not all software packages are configured to accommodate the FRS, and many will only permit sales to be recorded as standard rated, reduced rated, zero rated or exempt. Users of the FRS should use one of the following methods to record sales: