The flat rate VAT scheme is an incentive provided by the government to help simplify taxes and means you charge VAT on your invoices at 20% (2016 rate) but only pay back HM Revenue and Customs at a lower rate, for IT Contractors (rates differ depending on your profession/trade – see table below) the rate in your first year is just 13.5% of the gross amount and 14.5% in subsequent years (you receive a 1% discount in your first year).
This provides the following additional income (based on a 45 week working year):
- £200 per day contract – £1,710 extra per year
- £350 per day contract – £2,992.50 extra per year
- £600 per day contract – £5,130 extra per year
The FRS is therefore the chosen scheme for most Contractors, Freelancers, Consultants and Interim Managers. It is also the scheme that is recommended for businesses that have very few VAT chargeable purchases and expenses i.e. don’t buy much stock.
Important notes about the FRS:
1.If you estimate that your annual turnover excluding VAT will exceed £150,000 in your first year, you shouldn’t join the scheme.
2.If your annual turnover exceeds £230,000 of VAT inclusive revenue in subsequent years you must come off the scheme.
3.Companies on the flat rate scheme are unable to claim back any VAT on purchased goods and expenses for their business. You can however reclaim VAT on capital asset purchases over £2,000, for example a PC. Providing all the capital purchases are on the same receipt such as a PC, printer and scanner you can claim the VAT back on these items. You cannot however buy a PC one month for £1,500 then a printer the next month for £300 and a scanner the month after for £200 and add them together; they must all be on the same receipt.
Like standard VAT, the flat rate scheme still requires you to complete a quarterly VAT return form (online only). You will need to charge the standard VAT rate, currently 20%, (2016) to your invoices, however…rather than accounting for the VAT on every payment, when you do your quarterly report you will only pay a single flat rate percentage on your turnover of each quarter.
The VAT percentage you pay is considerably lower than that of the standard VAT rate,(see below table for a full list of the standard rates depending on your profession) you then keep the difference as your profit. See example below based on a Limited Company specialising in IT:
Net amount you invoice your client £5,000
VAT charged on top to your client (20%) £1,000
Gross Amount £6,000
Flat rate VAT 13.5% (this includes a first year discount of 1%) 13.5%
VAT to be paid to HMRC – 13.5% of £6,000 £810
VAT received from client £1,000
Profit for you i.e. what you get to keep £190
Advantages of using the Flat Rate Scheme
- The ability to earn money from VAT, you can earn thousands of pounds extra each year simply out of VAT (the government does this as the FRS is simple for them to manage and you are in affect acting as a tax collector).
- A reduced amount of paperwork to handle as you are not submitting any of your input costs to HMRC all you need to do is keep the receipts from your purchases.
- If you are a new business, using the flat rate scheme in your first year, you receive a further 1% decrease on the overall percentage tax you pay each quarter.
Disadvantages of using the Flat Rate Scheme
•If you are buying lots of stock or have high VAT chargeable expenses you will miss out on reclaiming the VAT.