What Is the VAT Flat Rate Scheme?

The VAT Flat Rate Scheme is a simplified way of accounting for VAT. Instead of calculating the difference between the VAT you charge your customers (output tax) and the VAT you pay your suppliers (input tax), you pay HMRC a fixed percentage of your VAT-inclusive turnover. The percentage depends on your business sector.

You keep the difference between what you charge your customers and what you pay HMRC. In theory, that difference covers the VAT you incur on your own purchases. In practice, whether you come out ahead depends entirely on your cost base and which sector rate applies to you.

HMRC sets 23 sector-specific flat rates, ranging from 2% for some retail businesses to 14.5% for others. The standard flat rate for a business not covered by a specific sector is 12%. These rates apply to businesses registered for VAT under the scheme.

As ICAEW qualified accountants, we work through the numbers with clients regularly. The scheme is not a one-size-fits-all saving. It works brilliantly for some businesses and costs money for others.

Who Can Use the VAT Flat Rate Scheme?

Any VAT-registered business with a VAT-exclusive turnover of £150,000 or less in the next 12 months can join. That is the entry threshold. Once you are on the scheme, you can stay until your total business income (VAT-inclusive) exceeds £230,000 in a rolling 12-month period. At that point, you must leave.

You cannot use the flat rate scheme if you have voluntarily registered for VAT and are using the VAT Margin Scheme (common for second-hand goods dealers). You also cannot use it if you are a tour operator using the Tour Operators' Margin Scheme.

Most small limited companies, sole traders, and partnerships can join. Contractors working through their own limited company are frequent users, though the Making Tax Digital requirements apply to them as much as anyone else.

How to Register

You can apply to use the flat rate scheme when you first register for VAT (form VAT1). Or you can switch from standard VAT accounting later using form VAT600FRS. HMRC typically processes the application within 30 working days. You start using the scheme from the date HMRC confirms, not the date you apply.

Once accepted, you must use the scheme for at least 12 months. If you leave early, HMRC may charge you back any VAT you saved. The only exceptions are if your business ceases to trade or if your turnover exceeds the £230,000 threshold.

The Flat Rate Percentages for 2025/26

The rate you use depends on your business sector. HMRC publishes a full list, but the most common ones are:

  • Accountancy or bookkeeping: 14.5%
  • Computer and IT consultancy or data processing: 14.5%
  • Management consultancy: 14.5%
  • Advertising or public relations: 13%
  • Photography, radio, film or TV production: 13%
  • Construction, building or engineering (excluding labour-only subcontractors): 9.5%
  • Labour-only construction subcontractors (CIS): 14.5%
  • Hairdressing or beauty: 13%
  • Hotel or accommodation: 6.5%
  • Printing: 8.5%
  • Retail (excluding food, confectionery, newspapers, children's clothing, and some others): 7.5%
  • Retail (food, confectionery, newspapers, children's clothing): 2%
  • Social care: 11%
  • Transport or storage (including couriers, freight, removals): 10%
  • Wholesaling: 8.5%
  • Any other business not listed: 12%

The first year you join the scheme, you get a 1% discount on your sector rate. So an IT consultant whose first year rate would normally be 14.5% pays 13.5% for the first 12 months. After that, the rate reverts to 14.5%.

The Limited Cost Trader Rule

This is the single most important change to the flat rate scheme since its introduction. If HMRC classifies you as a "limited cost trader", you must use a flat rate of 16.5% regardless of your sector. That rate is higher than most sector rates and often makes the scheme uneconomical.

You are a limited cost trader if your VAT-inclusive expenditure on relevant goods is either:

  • Less than 2% of your VAT-inclusive turnover in a prescribed accounting period, or
  • Less than £1,000 per year if the 2% test gives you a figure above £1,000

"Relevant goods" means physical goods used exclusively for your business. It does not include:

  • Capital expenditure (like a van or a computer you claim capital allowances on)
  • Food or drink for consumption by you or your staff
  • Vehicle fuel (unless you are a transport business)
  • Goods for resale, leasing, or letting
  • Services of any kind (accountancy fees, software subscriptions, rent, utilities, insurance)
  • Goods used for non-business purposes

This rule catches most service-based businesses. A freelance consultant in Bristol paying for software, rent, and professional subscriptions but buying few physical goods will almost certainly be a limited cost trader. A builder buying bricks, timber, and plumbing supplies will not.

The 16.5% rate applies from the first day of your next VAT period after you become a limited cost trader. HMRC expects you to self-assess. If you get it wrong, you could face penalties and backdated VAT.

Worked Example: Does the Scheme Save You Money?

Let us run two scenarios to show when the scheme works and when it does not.

Scenario 1: A Builder in Sheffield (Not a Limited Cost Trader)

Marcus runs a small building firm in Sheffield. He charges 20% VAT on all his work. His quarterly VAT-inclusive turnover is £48,000. He spends £18,000 on materials (bricks, timber, cement, plumbing supplies) plus £6,000 on services (rent, insurance, accountancy).

Standard VAT accounting:
Output tax: £48,000 x 20/120 = £8,000
Input tax on materials: £18,000 x 20/120 = £3,000
Input tax on services: £6,000 x 20/120 = £1,000
VAT payable to HMRC: £8,000 - £3,000 - £1,000 = £4,000

Flat rate scheme (construction sector 9.5%):
Flat rate payable: £48,000 x 9.5% = £4,560

Marcus pays £560 more per quarter under the flat rate scheme. The scheme costs him money because his input VAT recovery on materials is high. He should stay on standard accounting.

Scenario 2: An IT Consultant in Manchester (Limited Cost Trader)

Sarah runs a software consultancy from her home office in Manchester's Northern Quarter. Her quarterly VAT-inclusive turnover is £36,000. She buys no physical goods for her business. Her costs are software subscriptions (£600), accountancy (£400), and marketing (£300) all services.

Standard VAT accounting:
Output tax: £36,000 x 20/120 = £6,000
Input tax: zero (no relevant goods, services only)
VAT payable to HMRC: £6,000

Flat rate scheme (limited cost trader 16.5%):
Flat rate payable: £36,000 x 16.5% = £5,940

Sarah saves £60 per quarter. Not a huge saving, but it simplifies her record-keeping. If she were not a limited cost trader (unlikely for an IT consultant), her sector rate of 14.5% would save her £1,020 per quarter. That is the difference the limited cost trader rule makes.

If Sarah's turnover were £50,000 per quarter, standard accounting would cost her £8,333 in VAT. The flat rate at 16.5% would cost £8,250. She saves £83. Hardly worth the administrative risk of getting the limited cost trader classification wrong.

When the Flat Rate Scheme Still Works Well

The scheme works best for businesses with low costs on physical goods. That means service businesses where the limited cost trader rule does not apply or where the sector rate is significantly below 16.5%.

Retailers selling zero-rated goods (food, children's clothes, newspapers) use a 2% flat rate. A corner shop in Birmingham's Jewellery Quarter with £100,000 of VAT-inclusive turnover pays just £2,000 in VAT. Under standard accounting, they would charge 20% on standard-rated goods but recover input tax on purchases. The 2% rate is generous, but only for that specific category.

Hotels and accommodation businesses use 6.5%. A small B&B in the Lake District with £80,000 VAT-inclusive turnover pays £5,200. Under standard accounting, they would pay more because their input VAT recovery is limited (food is zero-rated, most costs are services). The 6.5% rate usually saves them money.

Transport businesses (couriers, removals, freight) use 10%. A courier in Leeds with £60,000 turnover pays £6,000. Standard accounting would likely cost more because their main costs are fuel (where input VAT is partially restricted) and vehicle maintenance.

Common Mistakes and Pitfalls

Applying the wrong sector rate. HMRC publishes detailed guidance on which rate applies to which activity. If you do mixed work (e.g., a builder who also does consultancy), you use the rate for your main business activity. Getting this wrong can mean repaying VAT plus interest.

Ignoring the limited cost trader rule. This is the most common error we see. Businesses that used to benefit from a low sector rate suddenly find themselves at 16.5% and do not adjust their invoices. HMRC can go back four years and demand the difference.

Forgetting the 1% first-year discount. You must apply the discount to your sector rate, not to the 16.5% limited cost trader rate. The discount only applies to your genuine sector rate.

Not checking the turnover threshold. If your VAT-inclusive turnover exceeds £230,000 in any rolling 12-month period, you must leave the scheme. HMRC monitors this. Late departure means you account for VAT at standard rates from the date you exceeded the threshold.

Using the scheme for property transactions. The flat rate scheme does not apply to property sales or land transactions. Those must be accounted for under standard VAT rules even if you are on the flat rate scheme for your main business.

How the Flat Rate Scheme Interacts with Other VAT Rules

The flat rate scheme does not exempt you from Making Tax Digital for VAT. You still need compatible software (Xero, FreeAgent, QuickBooks) to submit your VAT returns digitally. The scheme simplifies the calculation, not the filing method.

If you use the flat rate scheme, you cannot reclaim input VAT on your purchases except for capital assets costing £2,000 or more (VAT-inclusive). That means a van purchase or a major piece of equipment still allows input VAT recovery under normal rules. You account for that separately on your VAT return.

Flat rate scheme users must still issue VAT invoices showing 20% VAT to their customers. The customer reclaims the full 20% as input tax. The flat rate only affects what you pay HMRC, not what you charge.

If you are a contractor caught by IR35, your deemed employment income is outside the scope of VAT. But the VAT you charge on your invoices still goes through the flat rate scheme. The two rules operate independently.

Should You Join the Flat Rate Scheme?

The answer depends on your specific numbers. Run the calculation both ways before deciding.

For most service businesses (IT consultants, accountants, management consultants, marketing agencies), the limited cost trader rule makes the flat rate scheme unattractive. You pay 16.5% instead of 20% on your output, but you lose the ability to reclaim input VAT on your costs. The net saving is usually small or negative.

For businesses with significant physical goods costs (builders, retailers, wholesalers, hotels, transport), the scheme can still save money. But you must check your sector rate against your actual input VAT recovery percentage.

If your input VAT recovery is above 50% of your output VAT, standard accounting almost always wins. If it is below 20%, the flat rate scheme likely saves you money provided you are not a limited cost trader.

We recommend running a 12-month projection. Use your actual purchase invoices to calculate your real input VAT recovery. Then compare it to the flat rate scheme result. Our VAT flat rate calculator can help you model both scenarios.

Leaving the Flat Rate Scheme

You can leave the scheme voluntarily after 12 months. You notify HMRC by writing to them or using your VAT online account. You then revert to standard VAT accounting from the start of your next VAT period.

If your turnover exceeds £230,000 (VAT-inclusive), you must leave. HMRC may also remove you if they decide the scheme is not right for your business. In practice, this happens most often when HMRC challenges a business's sector classification or limited cost trader status.

When you leave, you may need to adjust your VAT account for any capital assets on which you reclaimed input VAT. The adjustment is usually small but worth getting right.

Final Thoughts

The VAT flat rate scheme is not the automatic saving it was before the limited cost trader rule came in. For many small businesses, standard VAT accounting is now the better option. But for the right business in the right sector, the scheme still simplifies record-keeping and delivers a genuine saving.

If your turnover is approaching the VAT registration threshold of £90,000, you should plan ahead. Registering for VAT is not optional once you cross that threshold. The choice between standard accounting and the flat rate scheme is one you make at registration, not one you defer.

Our ICAEW qualified team at Holloway Davies can help you model the numbers and decide. We work with businesses across every sector from our offices in London, Manchester, Birmingham, and Bristol. If you are unsure whether the flat rate scheme works for you, get in touch.