Part of our complete guide to VAT & MTD.
What the flat rate scheme actually changes
Instead of tracking VAT on every sale and every purchase and paying HMRC the difference, the flat rate scheme has you pay a single fixed percentage of your gross (VAT-inclusive) turnover each quarter. The percentage depends on your trade sector, HMRC publishes the full list, and ranges roughly from 4% to 14.5% depending on the type of business. You still charge customers the standard 20% VAT on your invoices, you just hand over less than the full difference to HMRC, keeping the gap as a margin benefit.
Why it can save money
If your genuine input VAT, the VAT you pay on purchases and expenses, is low relative to turnover, the flat rate percentage is usually set below what you'd otherwise owe, so the gap becomes profit. This is the scheme's whole appeal for service businesses with few VAT-rated costs: consultants, freelancers, many online sellers.
Key point: You lose the ability to reclaim VAT on most individual purchases under this scheme. If you buy stock, equipment or supplies with real VAT attached regularly, the flat rate often ends up costing more than standard VAT accounting, not less.
The limited cost business trap
HMRC introduced a specific rule to stop the scheme being used purely as a margin play by businesses with almost no costs. If your spending on goods (not services) is under 2% of turnover, or under £1,000 a year if turnover is higher, you're a "limited cost business" and must use a flat 16.5% rate regardless of your actual sector. For most consultants and contractors with minimal goods spend, that 16.5% rate wipes out most or all of the saving the scheme was supposed to offer.
Who the scheme tends to suit
- Service businesses with genuinely low purchase VAT, where the sector rate is meaningfully below 20% and goods spending exceeds the 2% threshold
- Businesses that want simpler bookkeeping above all else, and are willing to accept a smaller or uncertain saving in exchange for less admin
It tends not to suit businesses making significant VAT-rated purchases, or anyone close to the limited cost business threshold, where the maths can flip against you without warning as spending patterns shift quarter to quarter.
Not sure which way the numbers fall for you? Book a free consultation and we'll run both scenarios, standard VAT accounting and the flat rate scheme, against your actual numbers before you commit, as part of our VAT returns service.
Frequently asked questions
What is the VAT flat rate scheme?
The flat rate scheme lets eligible small businesses pay VAT as a fixed percentage of their gross turnover, set by trade sector, instead of calculating input and output VAT separately on every transaction.
Who can join the flat rate scheme?
Businesses with expected VAT-taxable turnover of £150,000 or less in the next 12 months can apply, and you must leave once turnover exceeds £230,000.
Can I still reclaim VAT on purchases under the flat rate scheme?
Generally no, the flat rate percentage already factors in an assumed level of input VAT, except for a single capital asset purchase over £2,000 including VAT, which can be reclaimed separately.
What is a limited cost business under the flat rate scheme?
If your goods spending is below 2% of turnover (or below £1,000 a year), you're classed as a limited cost business and pay a higher 16.5% flat rate regardless of your actual trade sector rate, which usually makes the scheme not worth joining.