Pros & Cons of the Flat Rate Scheme

Understanding the Flat Rate Scheme and its related pros and cons can help businesses to better manage and process their VAT. The Flat Rate Scheme can simplify the VAT calculation process, which has many potential benefits from a business perspective.

However, it also comes with specific limitations that may not be suitable for every business. By gaining a clear insight into how the scheme operates and its impact on financial management, companies can make informed decisions about whether the Flat Rate Scheme aligns with their overall tax strategy and operational needs.

What is the Flat Rate Scheme for VAT? 

The Flat Rate Scheme offers VAT-registered businesses a simplified way to calculate the VAT they owe to HMRC. Instead of calculating VAT on each transaction, businesses using this scheme pay a fixed percentage of their total turnover, which varies depending on the type of business. This approach significantly reduces the administrative burden, as it simplifies record-keeping and reporting requirements. However, the convenience of the Flat Rate Scheme comes with potential downsides. While it streamlines the VAT calculation process, businesses might find themselves paying more VAT compared to the traditional method. Therefore, it’s essential for businesses to carefully evaluate whether the Flat Rate Scheme truly benefits them financially before opting in.

Who is eligible for the Flat Rate Scheme? 

Navigating whether your business is eligible for the Flat Rate Scheme may appear daunting, but the eligibility criteria are simple. Eligibility for the Flat Rate Scheme is based on the business’s annual VAT taxable turnover. In order to be eligible, businesses must expect their taxable turnover to be £150,000 or less per annum. Once a business has been accepted into the scheme, they can remain unless their turnover (including VAT) was more than £230,000 in the last 12 months. They will also no longer be eligible for the scheme if their expected turnover in the next 30 days is over £230,000. In these scenarios, a business will leave the scheme and calculate the VAT due to HMRC using traditional methods. If a business leaves the scheme, it cannot rejoin for a year. 

What are the pros of the Flat Rate Scheme? 

The Flat Rate Scheme has its fair share of practical advantages for businesses looking to save money and maximise efficiency. Designed to simplify the tax calculation process, the advantages of the Flat Rate Scheme include:

Simplified bookkeeping 

An obvious yet often underestimated advantage of the Flat Rate Scheme is simplified bookkeeping. The scheme means you won’t have to record the VAT for every sale or purchase, as well as avoid having to show VAT separately on invoices. This is because the VAT is paid to HMRC as a flat rate percentage, multiplied by the VAT-inclusive turnover during that financial period. By cutting down the amount of time you spend on record-keeping, you can facilitate the smoother monitoring of your cash flow. This can result in the more efficient management of a business’s finances, as cost and expenditure are easier to target and track. 

Time and cost savings 

The Flat Rate Scheme provides significant time and cost savings for smaller businesses. By streamlining VAT calculations and making the process more automated, this scheme allows businesses to spend considerably less time on recordkeeping and filing tasks. The simplified calculations eliminate the need to track VAT on every single transaction, which not only reduces the complexity of the process but also minimises the likelihood of errors. Plus, this reduction in paperwork directly translates to fewer hours spent on administrative tasks, freeing up valuable business hours that can be better utilised elsewhere. With less time required for handling VAT-related paperwork, businesses can reduce the need for dedicated staff to manage these tasks. 

Cash flow benefits 

The Flat Rate VAT Scheme helps businesses manage cash flow by offering predictable, fixed-rate VAT payments based on total turnover, which simplifies financial planning. As well as making VAT payments more predictable, it can potentially lower VAT liability compared to the standard method, freeing up cash for other business needs. The scheme’s simplified approach reduces the need for frequent adjustments, resulting in a more consistent and stable cash flow. By streamlining VAT calculations and reducing the complexity of recordkeeping, the scheme enables businesses to allocate more resources to other financial priorities, improving overall cash management.

What are the cons of the Flat Rate Scheme? 

The Flat Rate Scheme, whilst generally advantageous for small businesses, does have its equal share of disadvantages. Despite offering simplified calculations, it’s not always the best fit for businesses that may not benefit from the scheme’s flat rate percentages. These limitations can affect a business’s financial efficiency and overall control over its tax obligations.

Limited VAT recovery

The fixed-rate percentages are calculated without taking into consideration the actual VAT collected or paid on purchases. This inflexibility may result in higher tax payments and limited VAT recovery.  For example, a business that makes zero rated or exempt sales would still need to declare the fixed-rate percentage on all sales whether VAt ha been collected from the customer or not.  In addition, input tax recovery is not usually permitted except for capital item purchases over £2,000 so whilst a plumber could buy a new van and reclaim the VAt, they could not reclaim VAT on tools or materials or website development for example.  

Threshold impact

The threshold impact of a fixed-rate tax scheme can affect a business’s eligibility and growth decisions. As businesses approach the flat rate turnover threshold, they risk losing the benefits of the scheme and may have to switch away from flat rate to the normal accounting scheme. This can increase administrative burdens and potentially lead to higher tax liabilities. Additionally, the fear of crossing the threshold might discourage businesses from expanding, as they may wish to avoid the complexities associated with exceeding the limit, potentially hindering their long-term growth prospects.

Reduced control over VAT

The Flat Rate VAT Scheme can reduce a business’s control over its tax obligations. While the scheme simplifies VAT calculations, it removes the ability to adjust payments based on actual costs and revenue, potentially leading to overpayment and higher overall tax costs, limiting the business’s ability to optimise its tax management.

It is to be noted that many modern accounting software packages such as Quickbooks, Xero and Sage have the function to switch from flat rate to normal account scheme with relative ease.

How often do I submit VAT returns under the flat rate scheme? 

Under the Flat Rate VAT Scheme, businesses need to submit VAT returns on a quarterly basis. However, the specific frequency can vary depending on your business’s circumstances and the requirements set by HMRC. In most cases, businesses can request VAT returns annually (annual accounting scheme). To understand how the submission process relates to your business specifically, you may wish to check the specific guidelines using a VAT accounting service. 

Get in touch

Staying up to date with VAT changes can be challenging and time-consuming for your business. At Rayner Essex, our VAT experts can help keep you up to date whilst making sure that everything you do is compliant with all regulations, handling legislative updates so you don’t have to. We understand that your time is valuable, so we aim to provide you with peace of mind by managing your VAT obligations effectively. To find out more about how our team can help your business, get in touch today. 

Image by katemangostar on Freepik