Does the flat rate VAT scheme work for you?

(21/07/10)

The flat rate VAT scheme is promoted as a means for small businesses to simplify their VAT records, by allowing them to make one simple calculation of VAT due, based on a flat rate applied to what is known as flat rate turnover. However, operating the scheme correctly is not as simple as it might seem.

Entering the scheme
Formerly, a business had to calculate two figures, its taxable turnover and its business income, to determine its eligibility to enter and use the scheme. However, on 1 April 2009 HMRC introduced a measure to simplify this process. Now only one figure, taxable turnover, needs to be calculated. In order to be eligible to join the scheme this needs to be under £150,000. Taxable turnover is based on either invoiced totals or cash receipts, according to how the business calculates its liability under the scheme. It consists of standard, zero and reduced rated supplies, before VAT, and should not be confused with flat rate turnover.

How it works
Once in the scheme you need to apply the relevant flat percentage applicable for your main trade sector to your flat rate turnover in each quarter, and pay the resulting figure
as VAT to HMRC.

Your flat rate turnover should include all the sales (including VAT) you make as a VAT registered trader, whether they are standard, zero or reduced rated, or exempt.

Therefore even such transactions as the sale of a second hand car, any bank interest received from business bank accounts or rents from residential property, which are VAT-exempt, must be included in your flat rate turnover figure. This means you effectively pay VAT on the gross receipts of sales made on which you have not collected any VAT. You can stay in the scheme until your flat rate turnover, on the anniversary of the date you joined the scheme, exceeds £225,000.

If you trade through a company, total flat rate turnover comprises all of the income received by the company. If you are a sole-trader your flat rate turnover includes your main trade, and any letting income you receive in your sole name, as lettings are regarded as a business for VAT purposes. Lettings undertaken as a partnership, perhaps jointly with your spouse, are not included in your sole-trade business income.

Traps to avoid
The flat rate scheme poses a potential trap for buy-to-let landlords who have joined it because of a separate trade undertaken within the same legal entity (sole-trader,
company or partnership). In this case the proceeds from selling a let property must be included as flat rate turnover, and the flat rate should be applied to the total. You can withdraw from the flat rate scheme before you sell a high value item such as property, but you must then remain out of the scheme for at least 12 months, although HMRC may allow a one day re-admission if the sale is genuinely a one-off.

Once you are in the flat rate scheme you need to review your mix of sales at least once a year on the anniversary of joining the scheme, and adjust the flat rate to that applying to the majority of your sales. For example, if the owner of a pub sells food, and food makes up more than 50% of their income, the flat rate applicable to catering and restaurants (10.5%) must be used rather than the 5.5% that applies to pubs. Remember, the flat rates for most business sectors changed on 1 December 2008, when the standard rate of VAT was reduced to 15%, so please check that you are using the correct rate for your sector.

If you would like further advice in this area, please contact us.