The flat rate VAT scheme can be a very good deal for some small businesses, but not for others. Whether you make or lose money on the scheme largely depends on how unusual your business is compared to others in your trade sector, but there are some other strategies that can be employed.
The flat rate VAT scheme is designed to eliminate the need to record the VAT paid on all your purchases. Under the scheme you simply multiply the total of all supplies made by the business (including the VAT charged to customers) by a flat rate, set according to your main business activity. This is the amount of VAT payable to HMRC. If this calculation produces a lower figure than would result when you subtract the VAT paid on purchases from the VAT charged to customers (the normal quarterly VAT calculation), then you are a flat rate VAT winner. However, to check if you are a winner or loser, you have to keep track of the VAT you pay on purchases, which is what the flat rate scheme was supposed to avoid!
To win with the flat rate scheme you also need to have a relatively low flat rate percentage to apply. The percentage is determined by the trade sector for your business; for example Restaurants must use 12%, while Pubs use 5.5%. If your costs are low compared to an average business in your trade sector, then you are likely to be a flat rate winner.
If your business falls into two or more trade sectors, such as a pub with food sales, you must use the flat rate that relates to the sector which represents the largest part of your business. When joining the scheme, and on each anniversary, you must estimate the mix of sales from your various trade categories for the next year. If you think the mix will change you must adjust the flat rate used accordingly.
In your first year of VAT registration you are entitled to take one percentage point off the flat rate used. If you do not use the flat rate scheme immediately on registration, you will not benefit from the full advantage of the 1% discount. However, many new businesses should hold off using the flat rate scheme for at least one quarter so they can reclaim the VAT incurred on all the one-off start-up costs. It is also worth noting once you have entered the scheme you can still reclaim the VAT you have been charged on single purchases of capital expenditure goods where the amount of the purchase, including VAT, is £2,000 or more.
As you can see this is a complex area. If you have any questions please get in touch.