Assessing whether to register your business for the flat rate VAT scheme
I was helping a business associate today with some calculations regarding their VAT. In doing so, I discovered something surprising about the Government's flat rate VAT scheme that many people had not realised. I am glad I realised it now as my business could soon be registering for VAT and understanding the flat rate scheme is important in coming to a decision.
What is the flat rate VAT scheme?
For businesses with a relatively small turnover (less than 150000 net), they can opt to simplify their VAT returns by just paying a predetermined percentage of sales to HMRC without having to calculate the difference between their sales input and purchases output.
All you do, is report your gross turnover for the period concerned and pay them the predetermined percentage of that amount. So then can be no doubt that the scheme offers savings in terms of administration.
The motivation for most businesses is this savings in terms of administration coupled with potential savings in the amount of VAT you actually have to pay.
However, does it offer savings in terms of the amount of VAT you pay?
How the percentage is calculated
To illustrate this, let us take the case of a Hairdresser's business. At the time of writing this article, the standard rate of VAT is 20% and the flat rate for Hairdressers is 13%. On the face of it, this sounds like you keep 7% of the 20% VAT rate and pay the remaining 13% to the government.
But that is now how it works at all.
In my view, this is a bit sneaky on the government's part. But the proportion of the collected VAT that you pay to the government is considerably higher than first appears to be the case.
To illustrate this, let us assume the gross turnover of our example Hairdresser's business is £100,000. Paying VAT on the flat rate scheme is a very simple calculation of £13,000 (13% of £100,000).
However, the amount of VAT you would have paid under a normal VAT scheme is not £20,000, which is a figure you might assume instinctively. Rather, it is quite a bit less than this.
The figure of £100,000 is a gross figure. So to calculate the amount of VAT within this turnover we need to calculate it like this:
£100,000/120*20 = £16,666.67
And it gets worse. If you were paying VAT at the full rate, you would be entitled to claim back the VAT on all business purchases. So let us say for the sake of argument that you made purchases totalling £12,000 (gross) for the year. You can deduct the amount of VAT paid which is:
£12,000/120*20 - £2,000.00
So in this case, the amount you would have to pay is £14,666.67. This still means that you are better off on the flat rate scheme. However, if your purchases rise much above £10,000, it might be worth registering for the normal VAT rate.
So how does this difference arise?
The reason this is the case is very simple. VAT at 20% is applied to your net sales. The flat rate scheme which in this example if 13% is applied to your gross sales. Your gross sales are, of course, 20% higher than your net sales. That subtle difference in semantics makes quite a big difference to your bottom line.
So should I register for the flat rate VAT scheme for my business?
There is a good chance that this scheme could be good for you. As long as you understand the differences illustared above and can follow where to apply percentages to net and where to apply them to gross, you should be able to calculate whether it could be if financial benefit to your business.
Here is a simple calculation to calculate the trigger point above which it is better to opt for a normal VAT registration:
- Deduct the flat rate percentage from 16.67
- Multiply this fiugure by 6
- Apply the result as a percentage of your gross turnover
- This is the threshold above which, the flat rate scheme is no longer of any use to you
- 16.67 - 13.00 = 3.67
- x 6 = 22.02
- £100,000 x 22.02% = £22,020
So a hairdresser with a turnover of more than £100,000 should go for the flat rate scheme if total gross VAT purchases are less than £22,020 per year.
I hope I have explained that well!
NB - These calculations assume a VAT rate of 20%