VAT Flat Rate Scheme
Official Definition
According to HMRC, the Flat Rate Scheme is a simpler way to work out your VAT if you're a small business with turnover of £150,000 or less (excluding VAT). Instead of tracking VAT on every purchase and sale, you pay HMRC a fixed percentage of your VAT-inclusive turnover.
What It Is (Plain English)
Think of the Flat Rate Scheme as VAT on easy mode. Instead of keeping receipts for every expense and calculating VAT in and VAT out, you just multiply your turnover by your industry's flat rate percentage and send that to HMRC. For IT contractors, that's usually 14.5%.
The trade-off? You can't reclaim VAT on most expenses (except capital assets over £2,000). This makes it great for service-based businesses like contractors who don't have many purchases, but potentially bad for businesses with lots of expenses.
- Who can use it: VAT-registered businesses with turnover under £150,000
- IT contractors rate: 14.5% (13.5% first year)
- First year discount: 1% off your rate for first 12 months
- Limited cost trader rate: 16.5% if you spend little on goods
- Admin time: Much less than standard VAT
How It Works
On standard VAT, you charge 20% on sales, reclaim 20% on purchases, and pay HMRC the difference. It's accurate but requires tracking every receipt.
On Flat Rate, you charge 20% on sales (same as before), but then pay HMRC a fixed percentage of your gross turnover (including the VAT you charged). You keep the difference. You can't reclaim VAT on most purchases.
Scenario: Invoice £10,000 + £2,000 VAT. Buy £1,000 + £200 VAT of equipment.
Standard VAT:
- VAT collected: £2,000
- VAT paid on purchases: £200
- Pay HMRC: £2,000 - £200 = £1,800
- Keep: £10,000
Flat Rate (14.5%):
- Gross turnover (inc VAT): £12,000
- Pay HMRC: £12,000 × 14.5% = £1,740
- Keep: £12,000 - £1,740 = £10,260
- VAT on purchases: Can't reclaim
Result: You keep an extra £260 (£10,260 vs £10,000), but you couldn't reclaim the £200 VAT on purchases.
Flat Rate Percentages by Industry
| Industry | Rate | First Year Rate |
|---|---|---|
| Computer and IT consultancy or data processing | 14.5% | 13.5% |
| Accountancy or bookkeeping | 14.5% | 13.5% |
| Business services not listed elsewhere | 12% | 11% |
| Management consultancy | 14% | 13% |
| Architect, civil or structural engineer | 14.5% | 13.5% |
| Publishing | 11% | 10% |
| Limited cost trader (any industry) | 16.5% | 15.5% |
See full list of rates on Gov.uk
The Limited Cost Trader Rule
Since 2017, if you're a "limited cost trader", you must use the higher 16.5% rate instead of your industry rate. This catches most IT contractors who work from home with minimal expenses.
You're a limited cost trader if EITHER:
- Your goods cost less than 2% of your turnover in a quarter, OR
- Your goods cost less than £1,000 per year (if turnover is over £50,000), OR
- Your goods cost is less than 2% AND less than £250 in a quarter
"Goods" means physical items that form part of the work you sell or are used up in providing your service. It does NOT include:
- Capital assets (computers, cars, furniture)
- Food and drink for you or your staff
- Services (software subscriptions, hosting, accountants)
- Vehicle costs (fuel, insurance, repairs)
For most IT contractors, this means you're a limited cost trader and must use 16.5%, not 14.5%.
Quarterly turnover: £30,000
Goods purchased:
- Physical books for research: £50
- Printer ink and paper: £30
- Total goods: £80
Check: £80 < 2% of £30,000 (£600)? Yes.
Check: £80 < £250? Yes.
Result: Limited cost trader - use 16.5% rate.
When to Use Flat Rate
Good for:
- Service-based businesses (consultants, contractors, freelancers)
- Businesses with low material costs
- People who hate admin and tracking receipts
- First-year businesses (you get 1% discount)
- Businesses that can't reclaim much VAT anyway
Bad for:
- Businesses with high material or stock costs
- If you buy a lot of equipment (can't reclaim VAT)
- If your clients are mostly non-VAT registered (you don't need to charge VAT at all)
- Businesses near the £150,000 turnover limit
How to Calculate What You Pay
- Add up all your sales (including VAT you charged)
- Multiply by your flat rate percentage
- Pay that amount to HMRC
- Keep the rest
You invoiced £40,000 + £8,000 VAT = £48,000 total
Your flat rate: 16.5% (limited cost trader)
Pay HMRC: £48,000 × 16.5% = £7,920
You keep: £48,000 - £7,920 = £40,080
First Year Discount
In your first 12 months of VAT registration, you get a 1% discount on your flat rate. For IT contractors:
- Normal rate: 14.5% becomes 13.5%
- Limited cost trader: 16.5% becomes 15.5%
This makes Flat Rate especially attractive in your first year, even if you might switch to standard VAT later.
Leaving the Scheme
You must leave Flat Rate if:
- Your turnover goes over £230,000 (including VAT)
- You expect your turnover in the next 12 months to exceed £230,000
You can choose to leave voluntarily if standard VAT becomes better for you (e.g., you start buying lots of equipment).
Common Questions (FAQ)
Can I reclaim VAT on anything under Flat Rate?
Only on capital assets over £2,000 (like a car, expensive computer, or machinery). You can't reclaim on regular business expenses, even if they have VAT on them.
Do I still charge 20% VAT to my clients?
Yes! Flat Rate only changes what you pay HMRC, not what you charge customers. You still charge 20% VAT on your invoices.
How do I know my flat rate percentage?
Check HMRC's list of business types and find the closest match to what you do. Most IT contractors use "Computer and IT consultancy" at 14.5%, but check the limited cost trader rule - you might need to use 16.5%.
What if my business does multiple things?
Use the rate for your main business activity (the one that generates most income). If you genuinely have equal split between activities, you might need to track them separately or use standard VAT.
Can I switch between Flat Rate and standard VAT?
Yes, but you must notify HMRC and can usually only switch once per year (at the anniversary of joining the scheme). Some businesses do Flat Rate in first year (for the discount) then switch to standard.
Is Flat Rate worth it for me as an IT contractor?
Usually yes in your first year (13.5% or 15.5% rate). After that, it depends on your expenses. If you work from home with minimal purchases, Flat Rate at 16.5% is still simpler than standard VAT. If you buy lots of equipment, standard VAT might save you money because you can reclaim the VAT.
Do I pay the flat rate on all my turnover?
Almost all, yes. You exclude: sales of capital assets (selling old equipment), zero-rated supplies, and some other exceptions. But your main consultancy income is definitely included.
Flat Rate vs Standard VAT: Quick Decision Tree
- First year of VAT? → Use Flat Rate (get 1% discount)
- Buy lots of equipment or stock? → Consider standard VAT (can reclaim)
- Hate admin? → Use Flat Rate (much simpler)
- Turnover near £150k? → Might not be worth Flat Rate admin if you'll exceed it soon
- Service business with low costs? → Flat Rate probably better