There are three main VAT schemes, in addition to the standard accounting method, which are available to small businesses:
The Annual Accounting Scheme
The Flat Rate Scheme
The Cash Accounting Scheme
Several factors dictate whether these schemes are suitable for you.
Annual Accounting Scheme
The Annual Accounting Scheme, open to businesses with a taxable turnover up to £1.35 million, can either be combined with the flat rate scheme (please see below) or used by a business using standard VAT accounting.
Traders using the scheme are only required to file one VAT return at the end of each year, usually making nine interim VAT payments during the year, based on their estimated total liability for the year, followed by one balancing payment with the return.
This can reduce administration costs of preparing and submitting quarterly VAT returns and could potentially help a business manage cash flow.
However, it does have disadvantages. If turnover suddenly increases it can result in a large balancing payment at the end of the year. Similarly, if turnover decreases taxpayers will be overpaying tax throughout the year. It is not recommended for repayment traders as they will only receive one repayment per year.
The Flat Rate Scheme (FRS)
The Flat Rate Scheme is available to businesses with turnover up to £150,000.
Traders using the Flat Rate Scheme pay VAT as a fixed percentage of their VAT inclusive turnover but they cannot reclaim the VAT on purchases, except on certain capital assets costing more than £2,000. The percentage is less than the full rate of output tax to compensate traders for not being able to recover the input tax.
The actual percentage depends on the type of business.
Using the Flat Rate Scheme can save time by reducing record keeping and can make life easier because taxpayers do not need to worry about what expenses they can or cannot claim VAT on. Due to it simplicity, the likelihood of errors is reduced and traders will always know what tax to set aside for their VAT bill as it is a set percentage of their turnover. In the first year of registration, traders can benefit from a 1% reduction in the relevant percentage.
There are disadvantages too. The VAT due is calculated based on all turnover, including zero-rated and exempt supplies. If the trader buys a substantial amount of standard-rated items they cannot generally reclaim any VAT on these so the scheme may not be for them, although the relevant percentage to be applied may reflect that, based on the business category. The scheme cannot generate a refund, so repayment traders will not benefit from it.
In 2017 HMRC introduced a category of a ‘limited cost business’ which refers to those with few purchases of relevant goods:
Less than 2% of turnover
Less than £1,000 a year (if their costs are more than 2%)
Relevant goods is not easy to define. Please speak ask us for advice.
If this applies, those traders pay over a rate of 16.5% of their gross, VAT-inclusive sales price, which generally negates the cash advantage of the FRS.
Cash Accounting Scheme
A business can join the Cash Accounting Scheme if their estimated VAT taxable turnover for the next year is not more than £1.35 million. It must leave the scheme if taxable turnover exceeds £1.6 million.
This is similar to standard VAT accounting in that the VAT liability or refund is the difference between the VAT charged to customers and the VAT paid on qualifying purchases. The scheme differs in that VAT is accounted for when payment is made, rather than on the invoice date.
One of the scheme’s main advantages is that Output Tax is not due until the business receives payment of its sales invoices. If customers pay promptly, the advantage will be limited but could potentially push VAT collected into a later period, helping cash flow. This gives automatic bad debt relief because, as no payment is received, no output tax is due. Many businesses find it easier to think in terms of cash flows in and out of their business rather than in terms of invoiced amounts because VAT follows the actual cash situation.
The main disadvantage is that there is no input tax recovery until payment of a supplier’s invoice.
We are here to help if you want to discuss VAT schemes with us.