Having a concise understanding of the differences between standard VAT and flat rate VAT is an important aspect of running a small business. HMRC takes non-compliance incredibly seriously, with large penalties for business owners who avoid their VAT obligations.
With that in mind, you may be asking yourself: what is the difference between standard VAT and flat rate VAT?
If you’re a new business owner, WIS accountancy is here to advise you on the responsibilities you have with HMRC.
In this article, we’re going to focus on the differences between standard VAT and flat rate VAT, which should help you work out which scheme is best for your company.
How does VAT work?
Value-added tax, or VAT, is added to most goods and services. To qualify for VAT, a company must have a turnover of £85,000 or above.
If you are a sole trader, self-employed business owner or freelancer, it is your responsibility to add the national VAT rate to the price of your goods/services and submit a VAT return every quarter to HMRC.
This return must be sent even if no VAT is owed.
To find out more about VAT, head to our VAT guide where we discuss VAT in- depth.
Standard VAT rates explained
Your standard VAT return calculates how much VAT you owe to HMRC from revenue, minus the amount of VAT which can be reclaimed for business expenses. Your completed return will show how much you owe, or how much can be reclaimed from HMRC.
If you can reclaim more than you owe, HMRC will provide a refund of the difference.
For the majority of goods in the UK, the VAT rate is set at 20%. Some items, such as home energy and car seats, can be sold at a reduced rate of 5%. VAT is not applicable to most food, books, children’s clothing, property or financial transactions.
Flat rate VAT scheme: how does it work?
HMRC introduced what is known as the flat rate scheme to help simplify returns for small business owners. It also helps smaller firms to profit. Businesses which have a turnover of £150,000 or less (excluding VAT) are eligible for the flat rate VAT scheme.
When using the flat rate VAT scheme, companies pay a fixed rate to HMRC. Under flat rate, your business won’t be able to reclaim VAT on purchases, except for certain capital assets which exceed £2,000. However, you can keep the difference between VAT on sales and what you pay to HMRC.
As far as your own invoices are concerned, you will charge VAT as usual and clients won’t notice any change. Fixed VAT rates vary depending on the type of business you own. As a typical rule, the more you spend on materials and goods, the lower your flat rate percentage will be.
To find out about how flat rate VAT percentages are broken down by HMRC, you can take a look at the GOV website for further guidance.
How to work out flat rate VAT
To calculate the flat rate of VAT your business owes to HMRC, simply multiply the flat rate percentage of your business type by your turnover (with VAT included).
Companies which are operating in their first year as VAT-registered businesses will receive a 1% discount on the fixed-rate given by HMRC. Let’s use a quick example:
• Imagine a photography business which charges £500 for an event. The client is invoiced £500 plus the standard national VAT rate of 20%, which makes a total of £600.
• Your flat rate for the business is 11%, although the business is just six months old, which means VAT is reduced to 10%.
• Your business, therefore, owes 10% of £600 to HRMC, totalling £60.
If you would like to work out your own flat rate, you can do so at the official HMRC website.
What is the difference between standard VAT and flat rate VAT?
Those just starting out on their business journey may be asking ‘what is the difference between standard VAT and flat rate VAT?’ The difference is contained in the multiplier you add to your income for your VAT return.
Essentially, the flat rate scheme allows you to consider how likely you are to spend on things like raw materials, and allows you to set a rate based on the type of business you operate.
This allows firms which are below the entry threshold an opportunity to profit on VAT, and helps simplify their relationship with HMRC.
However, if you decide to use the flat rate scheme, or if your company turnover qualifies for the standard VAT scheme, you will need to charge 20% VAT on every sale.
For smaller firms and startups attempting to manage overheads and cash flow, the flat rate VAT scheme won’t necessarily be suitable. In some instances, it could actually limit the success of your business.
Find out more
If you need help and advice regarding VAT, please do not hesitate to contact us today. We are a family of businesses and can also assist customers with mortgages and business insurance too.