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VAT schemes and Making Tax Digital guide
How the Standard VAT, Flat Rate Scheme and Annual Accounting schemes work, when the limited-cost-trader trap applies, and what Making Tax Digital means for your business in 2026/27.
Tax year: 2026/27. Last reviewed: Mon Apr 06 2026 00:00:00 GMT+0000 (Coordinated Universal Time).
VAT scheme model (Excel)VAT registration thresholds
You must register for VAT when your taxable turnover in any rolling 12-month period passes £90,000, or when you expect it to pass that level in the next 30 days. You can also register voluntarily to reclaim input VAT on your costs, which often makes sense when you sell to VAT-registered businesses. The deregistration threshold is £88,000; if turnover falls below this you can apply to deregister.
Standard VAT
Under standard (normal) VAT accounting you charge 20% VAT on most sales and reclaim VAT on your business purchases (input tax). The net payable to HMRC is: VAT charged on sales minus VAT reclaimed on purchases. Most businesses file quarterly VAT returns. The standard scheme is almost always the right choice if your input VAT is material (you buy significant goods or equipment).
Flat Rate Scheme (FRS)
Under the FRS you pay a fixed percentage of your VAT-inclusive turnover to HMRC, rather than tracking input and output VAT separately. The rate varies by business sector. For service businesses the rate is typically 12.5% (for marketing or media agencies) or similar. The FRS simplifies administration but does not let you reclaim VAT on individual purchases.
The FRS can be financially better than standard VAT when your actual input VAT is low relative to what the flat rate implies.
The limited-cost-trader trap (16.5%)
If your business spends less than 2% of VAT-inclusive turnover on goods, or less than £1,000 per year on goods, you are a limited-cost trader and your flat rate is 16.5% regardless of your trade sector. Service businesses (consultants, agencies, trainers, most professional services) nearly always fall into this category because they buy very little in the way of physical goods.
At 16.5%, the FRS almost always costs more than the standard scheme for a service business. The VAT scheme model checks your numbers automatically:
- If goods spending is less than max(£1,000, 2% of gross turnover), the limited-cost rate of 16.5% applies.
- At £100,000 net turnover: gross turnover = £120,000; 2% = £2,400. If you spend £500 on goods, you are limited-cost and pay £120,000 x 16.5% = £19,800 under FRS vs £18,000 net under standard. Standard wins by £1,800.
Annual Accounting Scheme
The Annual Accounting Scheme (AAS) lets you file one VAT return per year instead of four. You pay nine monthly or three quarterly instalments based on last year's liability, then reconcile at year end. It reduces administration but can create cash-flow pressure if your payments are higher than actual liability. It is worth considering if you have very stable turnover and want less paperwork.
Cash Accounting Scheme
The Cash Accounting Scheme means VAT is paid or reclaimed when cash is received or paid, not when an invoice is issued. This helps businesses with long credit terms (you do not pay VAT before your customers pay you). Available up to £1.35m taxable turnover per year.
Making Tax Digital for VAT
MTD for VAT has applied to all VAT-registered businesses since April 2022. You must:
- Keep digital records of VAT transactions (using MTD-compatible software such as Xero, QuickBooks, Sage or FreeAgent).
- Submit VAT returns directly through compatible software (not via the old HMRC online portal).
If you are not yet using MTD-compatible software you are at risk of a penalty. The transition is straightforward once you are on a compatible platform.
Making Tax Digital for Income Tax (ITSA)
MTD for Income Tax Self Assessment (MTD ITSA) is a separate, larger change:
- From 6 April 2026: sole traders and landlords with qualifying income over £50,000 must use MTD-compatible software and submit quarterly updates to HMRC.
- From April 2027: the threshold drops to £30,000.
- Further phasing (lower thresholds) is expected but not yet legislated.
MTD ITSA replaces the annual Self Assessment return for in-scope businesses. Quarterly updates are not full returns but summaries; a final declaration replaces the annual return. If you are approaching the £50,000 threshold now, setting up MTD-compatible software and processes early avoids last-minute pressure.
Compare VAT schemes and find the right one
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