VAT Flat Rate Scheme: How It Works for Small Businesses
The VAT Flat Rate Scheme (FRS) is a simplified way of accounting for VAT, designed to reduce the administrative burden for small businesses. Instead of calculating the actual VAT on every purchase and sale, you pay a fixed percentage of your gross turnover (including VAT) to HMRC and keep the difference. This article explains who can use the scheme, how it works, and what to watch out for.
Who Can Use the Flat Rate Scheme?
According to HMRC's eligibility guidance, you can join the Flat Rate Scheme if your VAT-taxable turnover (excluding VAT) is £150,000 or less in the next 12 months[1]. You must be VAT-registered to join. You must leave the scheme if your total business income (including VAT) exceeds £230,000 in any 12-month period[2], or if you are no longer eligible for another reason.
How the Flat Rate Scheme Works
Under the FRS, you:
- Charge VAT to your customers at the standard rate (currently 20%)[3] as normal.
- Calculate the VAT you owe HMRC by applying a flat rate percentage to your gross turnover (including VAT).
- Keep the difference between the VAT you charged and the flat rate amount you pay to HMRC.
You cannot reclaim VAT on purchases (with one exception: capital goods costing £2,000 or more including VAT can be reclaimed separately[4]).
Flat Rate Percentages
The flat rate percentage you use depends on your type of business. HMRC publishes a full list of flat rate percentages by trade sector. Some common examples include:
- Accountancy or book-keeping: 14.5%[5]
- Computer and IT consultancy or data processing: 14.5%
- Hairdressing and other beauty treatment: 13%
- Labour-only building or construction services: 14.5%
- Management consultancy: 14%
- Pubs: 6.5%
- Retailing food, confectionery, tobacco, newspapers or children's clothing: 4%
- Retailing that is not listed elsewhere: 7.5%
In your first year of VAT registration, you receive a 1% discount on the flat rate percentage.[6]
Limited Cost Trader Rules
Since April 2017[7], businesses classified as "limited cost traders" must use a flat rate of 16.5%[8], regardless of their trade sector. You are a limited cost trader if your spending on goods (not services) is either:
- Less than 2% of your gross turnover in the VAT period[9], or
- More than 2% of your gross turnover but less than £1,000 per year (calculated as £250 per quarter for quarterly returns).
Goods for this purpose do not include capital goods, food and drink consumed by the business or its employees, or vehicles, vehicle parts and fuel (unless you are in the transport business)[10]. The limited cost trader rule was introduced to prevent businesses with very low goods costs from gaining an unfair advantage from the scheme.
The Flat Rate Scheme and Making Tax Digital
Businesses on the Flat Rate Scheme must still comply with Making Tax Digital for VAT[11]. You must keep digital records and submit your VAT return using MTD-compatible software. The VAT return for FRS businesses is slightly simpler because you do not need to track input VAT on most purchases, but you must still report the correct figures in all nine boxes of the VAT return.
The DIY Accounting spreadsheets include a VAT calculation section that works with the Flat Rate Scheme. You can submit your FRS VAT return through the free submission service at submit.diyaccounting.co.uk.
Should You Use the Flat Rate Scheme?
The FRS can save time and simplify your VAT accounting if you have relatively low costs for goods and services. However, it may not be beneficial if:
- You regularly reclaim significant amounts of input VAT on purchases.
- You are classified as a limited cost trader (the 16.5% rate may result in paying more VAT than under the standard scheme).
- Your business has a low profit margin, meaning the flat rate percentage could exceed the effective VAT rate under the standard scheme.
Consider running a comparison calculation over a few VAT periods to see which scheme is more cost-effective for your business. You can join or leave the scheme by writing to HMRC.
Article generated by Claude Code for DIY Accounting, February 2026. All information sourced from GOV.UK and HMRC guidance linked inline.
Tax reference: VAT Flat Rate Scheme – Source: GOV.UK: VAT Flat Rate Scheme (applicable tax year 2025/26)
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