What is the Flat Rate Scheme (FRS)?
The Flat Rate Scheme (FRS) for VAT is an alternative method for a business to calculate their VAT liability on their quarterly returns, designed to simplify record keeping for small businesses.
Under the typical/standard VAT scheme, each quarter a business needs to record the total amount of VAT collected from its customers, the total amount of VAT paid to its suppliers and then calculate the difference. This difference is the amount owed to (or from) HMRC.
Under the Flat Rate Scheme, a business applies a fixed rate percentage to their gross taxable sales and the result is the amount that is owed to (or from) HMRC.
The fixed rate percentage will vary depending on the businesses trade. Find out more below, we provide example workings for both schemes below.
Example A - Standard Scheme
Net Sales = £10,000
VAT @ 20% = £2,000
Net Purchases = £6,000
VAT @ 20% = £1,200
VAT Liability = £700
Example B - Flat Rate Scheme (assuming 7.5% rate)
Net Sales = £10,000
VAT @ 20% = £2,000
Gross Sales = £12,000
Multiply Gross Sales by 7.5%:
£12,000 x 7.5% = £900
VAT Liability = £900
Benefits of the Flat Rate Scheme
The main benefit of using the Flat Rate Scheme for VAT is that it can make preparing your VAT returns faster and easier. The reason for this is that the calculation is much more straightforward.
If you have minimal VATable expenditure (e.g. expenses with suppliers who charge you VAT) then you could also benefit from having a much lower VAT liability by being on the Flat Rate Scheme than if you were on the standard scheme.
Drawbacks of the Flat Rate Scheme
The biggest negative of the Flat Rate Scheme is that it does not allow you to reclaim any VAT from your purchases (e.g. Amazon UK PPC, Import VAT, Accounting Fees, etc). If your business is based in the UK and has a high level of purchases or imports, then your VAT liabilities may be higher on the Flat Rate Scheme than the Standard Scheme.
A second major drawback of the Flat Rate Scheme is that the Flat Rate applies to zero-rated sales too. This means that if your business sells zero-rated products (such as coffee) or exports a high number of goods outside of the EU (which are usually zero-rated for VAT purposes) then your VAT liability will be higher on the Flat Rate Scheme as the rate would also be applied to those sales, whereas on the Standard Scheme those sales would have included £NIL VAT.
Who is allowed to join the Flat Rate Scheme?
VAT registered businesses with a taxable turnover of <£150,000 may apply to join the Flat Rate Scheme.
A business can join the FRS at the same time as registering for VAT, or, at any point where they are VAT registered (so long as their taxable turnover is <£150,000).
When do you need to leave the Flat Rate Scheme?
Businesses must leave the Flat Rate Scheme and move onto the Standard Scheme of VAT when their taxable turnover exceeds £230,000.
If your turnover is between £150,000 and £230,000 you are not allowed to join the Flat Rate Scheme, although you can still stay on the scheme until you reach the £230,000 threshold.
If you register for VAT and also apply to join the FRS from the date of registration, this DOES NOT affect your right to reclaim pre-registration VAT on your first VAT return.
What Flat Rate Scheme percentage should you use?
Each type of business activity has its own fixed flat rate percentage associated with it, see HMRC’s table for reference.
The commonly used fixed percentage for an ecommerce business is 7.5% - as this is the flat rate percentage if a business‘ main activity is “retail not listed elsewhere”.
Flat Rate Scheme if you have multiple trades
However, if there is more than one business activity, you would need to prioritise the fixed rate according to which activity is conducted the most.
Flat Rate Scheme - Limited Cost Traders
In order to prevent businesses from abusing the Flat Rate Scheme, in April 2017 HMRC introduced the concept of “Limited Cost Traders”.
If your business purchases VATable goods costing a total of less than 2% of your annual turnover (OR if the goods cost more than 2% but less than £1000 a year) then your business will be classified as a “limited cost trader”.
If you are a Limited Cost Trader then, regardless of your businesses trade, you will need to use a flat rate of 16.5% when preparing your VAT return.
Since 16.50% of 120% = 19.80% this means that in almost all cases, being a Limited Cost Trader and being on the Flat Rate Scheme brings virtually no benefit. In fact, it usually means that you are usually much better off being on the standard scheme.
Should I be on the Flat Rate Scheme or the Standard Scheme for VAT?
As a rule of thumb, it is usually more beneficial for ecommerce businesses to register for the Standard Scheme for VAT.
In general, the VAT they are able to reclaim from their purchases is usually much lower than the benefit provided by the flat rate of 7.5%.
There are obviously exceptions to this rule and ultimately you, as a business owner, will need to look at your current and expected outgoings before making a decision about whether to apply to join the Flat Rate Scheme.
Before you make your decision, you will need to consider the following:
- What expenses do you have that incur VAT?
- Is the business profitable?
- Do you have any major purchases planned in the coming months (e.g. have you placed several large goods orders for Christmas that will incur import VAT when imported into the UK)?
- Do you incur any zero-rated sales? If so, what is the percentage of these of your total sales?
We are Accountants for Ecommerce, and we work with all types of Ecommerce businesses. If you have any questions about Flat Rate VAT or if you need help making a decision about whether to apply to be on the Flat Rate Scheme vs Standard Scheme of VAT then get in touch with us today.