Four VAT schemes cover most UK businesses: Standard accounting, the Flat Rate Scheme, Cash Accounting and Annual Accounting. Your scheme does not change the VAT you charge customers. It changes when you pay HMRC and how you work out the amount.
This guide looks at flat rate versus standard VAT. It also covers the cash accounting rules and the annual option. Scheme choice comes after you register. The £90,000 turnover test decides when you need to sign up. Our guide to the VAT registration threshold covers that test. The application steps are in our guide on how to register for VAT.
What Are the Main VAT Schemes in the UK?
Four schemes cover most UK businesses. Standard accounting is the default, so there is nothing to apply for. The Flat Rate Scheme replaces line-by-line VAT with one set percentage of your gross turnover. Cash accounting delays your VAT payments, and annual accounting cuts you down to one return.
Here’s how the four compare.
| Scheme | Turnover limit to join | What it changes |
|---|---|---|
| Standard accounting | None | Nothing. It’s the default. |
| Flat Rate Scheme | £150,000 excluding VAT | You pay a fixed percentage of gross turnover |
| Cash Accounting | £1.35 million | You pay VAT after your customer pays you |
| Annual Accounting | £1.35 million | One return a year, plus advance payments |
All four schemes still run through Making Tax Digital software, so you still need quarterly records. Two of them also need an application to HMRC before you start.
Should You Stay on Standard VAT Accounting?
Standard accounting is the default and needs no application. You charge VAT on sales and reclaim it on costs. HMRC takes the difference every quarter through MTD software. The catch is timing, because you owe the VAT from the invoice date.
Long payment terms make the invoice date rule bite hardest. You raise a £12,000 invoice in March. You pay HMRC the £2,000 VAT on your March quarter return. Your customer settles in July.
Standard accounting works best when your input VAT is high. Stock, tools, materials, subcontractors and equipment all carry reclaimable VAT. A retailer or builder usually gets more back than a flat rate percentage saves.
It also works better when you have mixed rates. Zero-rated food, reduced-rate energy and exempt income all behave differently under a flat rate.
What Is the VAT Flat Rate Scheme and Who Qualifies?
You can join the Flat Rate Scheme if your VAT taxable turnover is £150,000 or less. That figure excludes VAT and looks ahead 12 months. You then pay HMRC a fixed percentage of your gross takings. You keep the difference, but you give up most VAT reclaims.
The rate depends on what your business does. Accountancy and bookkeeping are 14.5%. Advertising is 11%. General building work is 9.5%. Retailing food is 4%. HMRC's flat rate table lists every trade sector.
New registrations get a 1% discount for the first year. So a 14.5% trade pays 13.5% for twelve months.
HMRC blocks you from the scheme in six cases:
- you left the scheme in the last 12 months
- you committed a VAT offence in the last 12 months
- you joined a VAT group, or could have, in the last 24 months
- you registered as a business division in the last 24 months
- your business is closely linked to another business
- you already use a margin or capital goods scheme
One more rule catches people out: you cannot use the Flat Rate Scheme and cash accounting together. The flat rate scheme has its own cash-based turnover method instead.
How Do You Work Out Your Flat Rate Payment?
You multiply your flat rate by your VAT-inclusive turnover. In other words, use gross takings, not the net figure on the invoice. Plenty of online guides get this wrong and apply the rate to net sales. That understates the bill by a fifth.
HMRC gives a worked example. You bill a customer £1,000 and add 20% VAT. The invoice totals £1,200. You’re a photographer, so your rate is 11%. You pay HMRC 11% of £1,200, which is £132.
What happens here is simple. You collected £200 of VAT and handed over £132. The £68 gap is your gain, and it counts as taxable profit.
Now run the same sum on net turnover. An 11% rate on £1,000 gives £110. That is £22 short of the real bill on every £1,200 invoice.
Your VAT-inclusive turnover is wider than you might think. It picks up zero-rated sales and most exempt income too. A consultant with rental income can get an unpleasant surprise here.
What Is the Limited Cost Business Test?
HMRC treats you as a limited cost business if you spend very little on goods. The test is goods costing under 2% of turnover. If your goods pass 2%, they still have to top £1,000 a year. Fail the test and your rate jumps to 16.5%.
At 16.5%, the benefit almost disappears. Take the same £1,200 invoice. You collected £200 of VAT. At 16.5% you hand HMRC £198. You keep £2.
Two pounds does not cover the extra bookkeeping. It also does not make up for the VAT you can no longer reclaim.
Goods means physical items you use in the business. Services do not count. Software downloads, accountancy fees, rent, advertising and travel sit outside the test. So do capital items, plus food and drink for staff. Fuel counts only in a transport business.
Consultants, designers, IT contractors and coaches usually land in this bracket. HMRC runs an online checker so you can test a period before you commit.
Flat Rate vs Standard VAT: Which Saves More Money?
Flat rate works when your costs are low and your customers are VAT registered. Standard works when you buy a lot of VATable goods. Work out your reclaimable input VAT for a full year. Compare it with the gap between 20% and your flat rate.
Here is the simple version. Under standard accounting you hand over output VAT and reclaim input VAT. Under flat rate you pay one percentage and reclaim almost nothing.
So the real question is simple. Does your yearly input VAT beat the flat rate saving? A consultant with £600 of reclaimable VAT usually says no. A builder buying materials usually says yes.
One exception matters on the Flat Rate Scheme. You can reclaim VAT on one capital asset costing £2,000 or more including VAT. A £3,000 laptop counts. Three £1,000 laptops from one supplier at the same time count as one purchase.
Pricing matters too. Flat rate gains disappear if your customers cannot reclaim VAT themselves. Selling to consumers means the 20% comes straight out of your price point.
What Is the Cash Accounting VAT Scheme?
Cash accounting ties your VAT to money moving, not invoice dates. You pay HMRC only after your customer pays you. You reclaim VAT after you pay your supplier. You can join with estimated VAT taxable turnover of £1.35 million or less.
Bad debt protection comes built in. If a customer never pays, they never trigger a VAT bill. Under standard accounting you’d pay the VAT first and claim bad debt relief later.
The trade-off comes on the buying side. You cannot reclaim input VAT until the money leaves your bank. A business on 60-day supplier terms waits longer for every reclaim.
Cash accounting suits service firms with slow payers. It suits construction, agencies and consultancies well. It suits a cash-in-hand retailer badly, because sales settle straight away and stock sits on credit.
Which Sales and Purchases Stay Outside Cash Accounting?
Cash accounting does not cover every transaction. HMRC carves out five types and pushes them back to standard accounting. Long payment terms, advance invoices and credit deals all sit outside it. Most guides skip this, and it catches businesses out at their first return.
HMRC's cash accounting rules names the five:
- invoices with payment terms of six months or more
- invoices you raise in advance of the work
- goods you buy or sell under hire, lease, conditional sale or credit sale deals
- goods you bring into Northern Ireland from the EU
- goods you move out of a customs warehouse
So a plant hire firm uses two methods at once. Cash accounting handles the ordinary jobs. Standard accounting handles the hire agreements.
Three other bars apply to the scheme itself. You cannot join if you are behind on VAT returns or payments. You cannot join after a VAT offence in the last 12 months. You cannot join while you are on the Flat Rate Scheme.
Should Your Business Use the VAT Annual Accounting Scheme?
Annual accounting cuts four returns down to one. You pay instalments through the year and settle the balance at the end. The joining limit is £1.35 million of estimated VAT taxable turnover. It suits steady businesses and works badly for anyone who claims refunds often.
You pay in advance, either monthly or quarterly. Monthly instalments are 10% of your estimated bill. They fall due at the end of months 4 to 12. Quarterly instalments are 25%. They fall due at the end of months 4, 7 and 10.
Your final payment lands within two months of month 12. Your one return is due two months after your accounting period ends. HMRC's annual accounting payment deadlines sets out both dates.
HMRC bases your instalments on last year’s figures. Grow fast and you will face a large balancing payment. Shrink and you will have overpaid HMRC all year.
One warning matters most. You only get one VAT refund a year on this scheme. A repayment trader, such as a zero-rated food producer, should stay well clear.
When Do You Have to Leave a VAT Scheme?
Each scheme has its own exit limit and its own test. The Flat Rate Scheme uses £230,000 including VAT. Cash accounting and annual accounting both use £1.6 million. Leave late and HMRC treats your returns as wrong from the exit date.
The Flat Rate Scheme has three separate exit tests. Two of them are easy to miss:
- your turnover for the last 12 months tops £230,000 on your joining anniversary
- you expect it to top £230,000 over the next 12 months
- you expect income above £230,000 in the next 30 days alone
That third test looks forward, not back. One big contract can push you out with no warning.
Cash accounting ends when your VAT taxable turnover tops £1.6 million. Annual accounting ends when turnover is likely to top £1.6 million at year end.
Flat rate and annual accounting both lock you in for 12 months. Cash accounting has no such lock. You can rejoin it at the start of any VAT period.
Which VAT Scheme Should You Choose?
Start with your costs, then look at your payment terms. Low costs and quick payers point to the Flat Rate Scheme. High costs and quick payers point to standard accounting. Slow payers point to cash accounting, whatever else you are deciding.
Run through these four questions.
- What’s your reclaimable input VAT for a full year? Under about £1,000 and flat rate deserves a look.
- Would HMRC call you a limited cost business? A 16.5% rate usually kills the case for flat rate.
- How long do your customers take to pay? Past 45 days and cash accounting earns its keep.
- Do you claim VAT refunds most quarters? If yes, rule annual accounting out now.
Your scheme also changes your quarterly workload. Flat rate cuts the bookkeeping. Cash accounting adds a payment-matching job on every invoice. Plenty of small firms hand the quarterly work over. We handle outsourced VAT returns and keep the scheme maths right.
One last timing point: you can apply for annual accounting and the Flat Rate Scheme together. HMRC still treats them as two applications. Send both, or the second one will not happen.
Written by Raqeeb Marzook, ACCA, Manager at DASA Accountancy.
This article is a general guide to UK VAT accounting schemes. Rates, limits and rules change. Speak to a qualified accountant before you join or leave a scheme.
Picking the scheme takes an afternoon. Getting the returns right takes every quarter after that. Talk to us about DASA's VAT filing service. Get a quote and we’ll send you our current pricing.
FAQs
What are the main VAT schemes in the UK?
Four schemes cover most UK businesses. Standard accounting is the default and needs no application. The Flat Rate Scheme replaces line-by-line VAT with one set percentage of gross turnover. Cash accounting delays your VAT until the customer pays, and annual accounting cuts you down to one return a year.
Who can join the VAT Flat Rate Scheme?
You can join if your VAT taxable turnover is £150,000 or less excluding VAT over the next 12 months. HMRC blocks you if you left the scheme in the last 12 months, committed a VAT offence in the last 12 months, joined a VAT group in the last 24 months, or already use a margin scheme.
How do you work out a flat rate VAT payment?
You multiply your sector flat rate by your VAT-inclusive turnover, not your net sales. HMRC’s example bills £1,000 plus £200 VAT, giving £1,200. A photographer on 11% pays 11% of £1,200, which is £132. Applying the rate to net turnover understates the bill.
What is a limited cost business for VAT?
A limited cost business spends less than 2% of turnover on goods, or spends more than 2% but under £1,000 a year. Limited cost businesses pay a flat rate of 16.5%. On a £1,200 invoice carrying £200 of VAT, that leaves the business £2.
Is flat rate or standard VAT better?
Flat rate suits low-cost service businesses whose customers reclaim VAT. Standard accounting suits businesses buying stock, materials or equipment, because they reclaim input VAT in full. Compare a full year of reclaimable input VAT against the gap between 20% and your sector flat rate.
What transactions are excluded from the VAT Cash Accounting Scheme?
Five types stay on standard accounting. Invoices with payment terms of six months or more, invoices raised in advance, goods bought or sold under hire, lease, conditional sale or credit sale deals, goods brought into Northern Ireland from the EU, and goods moved out of a customs warehouse.
When must you leave the VAT Flat Rate Scheme?
You leave if turnover for the last 12 months tops £230,000 including VAT on your joining anniversary. You also leave if you expect to top £230,000 in the next 12 months, or expect income above £230,000 in the next 30 days alone. You wait 12 months before rejoining.