VAT Schemes for Small Businesses

The Flat Rate Scheme (FRS) is designed to simplify VAT accounting for smaller businesses. Instead of calculating the VAT on every sale and purchase, you pay HMRC a fixed percentage of your gross (VAT-inclusive) turnover. The percentage depends on your business sector — it ranges from around 4% for retailers of food to 14.5% for labour-only building or construction services. The full table of flat rates is published on GOV.UK.

The appeal of the FRS is that in some sectors you pay less to HMRC than the VAT you collect from customers, keeping the difference as a gain. For example, a business charging 20% VAT on sales but paying only 12% of gross turnover under the FRS retains the 8% difference. However, you cannot reclaim input VAT on purchases under the FRS (except for certain capital items costing over £2,000 including VAT), so the scheme is most advantageous for businesses with low input costs.

To join the FRS your taxable turnover must be £150,000 or less (excluding VAT) at the time of application. You must leave the scheme once your gross turnover (including VAT) exceeds £230,000. There is a 1% discount on your flat rate percentage during the first year of VAT registration.

Be aware of the limited cost trader rule introduced in April 2017. If your VAT-inclusive spend on goods is less than 2% of your gross turnover (or less than £1,000 per year), you must use a flat rate of 16.5% regardless of your sector — this largely eliminated the gain from the FRS for service businesses with minimal goods purchases. Businesses primarily selling services (consultants, IT contractors, agencies) should calculate whether the FRS still offers any benefit before joining.

Under standard VAT accounting, VAT becomes due on the invoice date — meaning you may have to pay HMRC for VAT on sales you have not yet been paid for. This can create significant cash flow pressure, particularly for businesses that extend credit to customers or deal with slow-paying clients.

The Cash Accounting Scheme solves this by letting you account for VAT on the basis of cash received and paid rather than invoice dates. You only pay output VAT to HMRC when the customer actually pays you, and you only reclaim input VAT on purchases when you actually pay your supplier. This means if a customer does not pay, you have automatic bad debt relief — you never paid the VAT to HMRC in the first place.

To use the Cash Accounting Scheme your taxable turnover must be £1.35 million or less. You must leave the scheme once your turnover exceeds £1.6 million. The scheme is not available if you have outstanding VAT returns or have a VAT debt. You do not need to notify HMRC to join — you simply start using the scheme and record the date you joined.

The main drawback is that if you have high input costs and pay your suppliers quickly while extending long credit to customers, you may reclaim input VAT more slowly than under standard accounting. Consider your specific payment terms before deciding. The scheme can be combined with the Annual Accounting Scheme but cannot be combined with the Flat Rate Scheme.

Standard VAT-registered businesses must submit a VAT return every quarter — four returns per year. The Annual Accounting Scheme reduces this to a single annual VAT return, potentially saving time and reducing the risk of missed deadlines and penalties. In exchange, you make advance payments during the year based on your estimated annual VAT liability.

There are two payment options under the scheme. With nine monthly instalments, you pay 10% of your estimated liability each month for months 4 to 12 of your VAT year, with the balance due two months after the year end. With three quarterly instalments, you pay 25% of your estimated liability at the end of months 4, 7, and 10, with the balance again due two months after the year end. HMRC bases the advance payments on your previous year's liability, or a reasonable estimate if you are new to the scheme.

Eligibility requires a taxable turnover of £1.35 million or less. You must leave the scheme if turnover exceeds £1.6 million. The scheme suits businesses with relatively predictable VAT liabilities where the simplicity of one annual return outweighs the need to have a clear picture of the VAT position each quarter. It can be combined with the Cash Accounting Scheme.

The VAT Margin Scheme is designed for businesses that buy and sell second-hand goods, works of art, antiques, and collectibles. Under standard VAT rules, VAT would be charged on the full selling price — but these goods have often already had VAT charged on them when originally sold new, making double taxation unfair. The Margin Scheme charges VAT only on the difference between the buying price and the selling price (the gross margin).

To use the Margin Scheme, you must keep detailed stock records linking each item bought with its subsequent sale, and your invoices to customers must not show VAT separately (since you cannot charge VAT on the full price). The customer therefore cannot reclaim any VAT, which means the scheme is mainly suitable for sales to consumers rather than VAT-registered businesses.

There are separate margin schemes for auctioneers, motor dealers, and for tour operators (the Tour Operators Margin Scheme or TOMS). Each has specific rules and record-keeping requirements. Businesses dealing in eligible goods should review the relevant HMRC guidance carefully before applying the scheme, as errors in record-keeping can disqualify the goods from margin scheme treatment and result in VAT being due on the full selling price.

Items that cannot use the Margin Scheme include: goods purchased from a VAT-registered person who charged VAT separately on the purchase (these are new, not eligible second-hand goods in this context); precious metals and investment gold; and certain categories of financial instruments. HMRC publishes detailed guidance on what qualifies.