The Flat Rate Scheme (FRS) is an alternative VAT system designed to simplify things for small businesses. But simpler doesn't always mean cheaper.

How Standard VAT Works

Standard VAT:

1. Add 20% VAT to all your sales (output VAT)

2. Reclaim 20% VAT on all your purchases (input VAT)

3. Pay HMRC the difference

Example:

• Sales: £10,000 + £2,000 VAT = £12,000
• Purchases: £4,000 + £800 VAT = £4,800
• You owe HMRC: £2,000 - £800 = £1,200

How Flat Rate Scheme Works

Flat Rate:

1. Add 20% VAT to your sales

2. Pay HMRC a fixed percentage of your gross turnover

3. You cannot reclaim VAT on purchases (except capital assets over £2,000)

Example (using 14.5% flat rate for IT consultancy):

• Sales: £10,000 + £2,000 VAT = £12,000 gross
• You owe HMRC: £12,000 × 14.5% = £1,740

In this case, standard VAT (£1,200) is better than flat rate (£1,740).

When Flat Rate Is Better

If you have low costs:

Service businesses with minimal purchases benefit most.

Freelance designer:

• Sales: £10,000 + £2,000 VAT
• Purchases: £500 + £100 VAT
• Standard VAT owed: £2,000 - £100 = £1,900
• Flat rate owed (12.5%): £12,000 × 12.5% = £1,500

Flat rate saves you £400.

When Standard VAT Is Better

If you have high costs:

Product-based businesses or those with heavy equipment costs.

Retail shop:

• Sales: £20,000 + £4,000 VAT
• Purchases (stock): £12,000 + £2,400 VAT
• Standard VAT owed: £4,000 - £2,400 = £1,600
• Flat rate owed (7.5%): £24,000 × 7.5% = £1,800

Standard VAT saves you £200.

Flat Rate Percentages by Sector

• Accountancy: 14.5%
• Advertising: 11%
• Architect: 14.5%
• Computer repair: 10.5%
• Hairdressing: 13%
• Hotel/accommodation: 10.5%
• Pubs: 6.5%
• Restaurants: 12.5%
• Retail: 7.5%
• Web design: 12.5%

[Full list on GOV.UK]

First Year Discount

In your first year of VAT registration, you get an extra 1% discount.

Example:

• Normal rate: 14.5%
• First year rate: 13.5%

This makes FRS more attractive initially.

Limited Cost Trader Rules

Important: If your VAT-inclusive purchases are less than either:

• 2% of your VAT-inclusive turnover, OR
• £1,000 per year (if that's higher)

You're a "limited cost trader" and must use a 16.5% flat rate (regardless of your industry).

This stops very low-cost businesses from gaming the system.

Making the Decision

Choose Flat Rate if:

• Low purchases/expenses
• Prefer admin simplicity
• Mostly service-based work

Choose Standard VAT if:

• High reclaimable purchases
• Product-based business
• Large equipment/asset purchases

Calculate both ways for a typical quarter and compare.

Use our VAT Calculator to model both scenarios.