The short answer
Under the VAT Flat Rate Scheme you pay HMRC a fixed percentage of your VAT-inclusive turnover and generally cannot reclaim VAT on purchases. You can join if you expect taxable turnover of £150,000 or less. Businesses that spend very little on goods are limited cost traders and pay 16.5%, which often removes the benefit.
The VAT Flat Rate Scheme sounds like a gift: pay a single percentage of turnover and stop worrying about every VAT receipt. For some businesses it genuinely is. For many service businesses, however, it turns out to cost more than standard VAT accounting, particularly since the limited cost trader rule arrived. This article explains how the scheme works, what the rates are and how to decide whether it is worth using.
What the scheme is
Normally, you charge VAT on your sales, reclaim VAT on your purchases and pay HMRC the difference. Under the Flat Rate Scheme, you still charge your customers VAT at the normal rate and issue normal VAT invoices. But when you file your return, you pay HMRC a fixed percentage of your gross, VAT-inclusive turnover instead of the difference between output and input VAT. You keep the difference between the VAT you charged customers and the flat rate percentage you pay HMRC.
For example, with £10,000 of sales plus £2,000 VAT, you collect £12,000. If your flat rate is 12%, you pay HMRC 12% of £12,000, which is £1,440. You keep the other £560. You cannot reclaim VAT on most purchases, so any VAT you paid to suppliers is simply a cost.
Who can join
You can join if you expect your taxable turnover, excluding VAT, to be £150,000 or less over the next 12 months. You must leave the scheme if your total business income exceeds £230,000, including VAT. You cannot join if you are in certain other schemes or have been involved in specific tax avoidance, and rules differ for groups of companies.
How the percentage is set
The rate depends on your trade sector, such as accountancy, building, catering or retail. HMRC publishes the list of rates, which range from single digits to the high teens. In your first year of VAT registration you receive a 1 percentage point discount on your rate.
The limited cost trader rule
This is the part that catches people. A business is a limited cost trader if its spend on relevant goods is less than 2% of its VAT-inclusive turnover, or less than £1,000 a year if that is greater. Relevant goods exclude capital items, food and drink for yourself or employees, vehicles, fuel (with exceptions) and many other categories. In practice, service businesses with low costs, such as consultants, contractors and freelancers, are often limited cost traders.
Limited cost traders must use a flat rate of 16.5% of turnover, regardless of sector. That is high. A consultant who bills £5,000 plus £1,000 VAT, and so collects £6,000, pays HMRC 16.5% of £6,000, or £990, and keeps only £10 of the VAT, compared with paying £1,000 under standard accounting and reclaiming little input VAT. The benefit is tiny, and sometimes negative once you consider the admin.
A worked comparison
Suppose a contractor invoices £60,000 a year plus VAT, with £2,000 of VAT-bearing costs, which gives £400 of input VAT.
Standard accounting: output VAT £12,000, input VAT £400, pay HMRC £11,600.
Flat Rate Scheme, limited cost trader: gross turnover £72,000 × 16.5% = £11,880. Pay HMRC £11,880.
Standard accounting is £280 cheaper. If the same contractor had large purchases with VAT, the gap would be wider. If they were not a limited cost trader and had a 10% rate, they would pay £7,200 and be £4,400 better off. The outcome depends on your costs, so run both numbers with your real figures.
When the scheme works well
- Businesses with a low flat rate, for example trades with a sector rate in the single digits or low teens
- Businesses with few VAT-bearing costs who are not limited cost traders
- Businesses that want simpler record keeping
- Businesses in their first year, with the 1% discount
When standard accounting is better
- Limited cost traders paying 16.5%
- Businesses with large VAT-bearing purchases, which they could reclaim
- Businesses buying capital equipment over £2,000 including VAT, because you can reclaim VAT on those items separately even within the scheme, but the other rules still apply
- Businesses selling mostly zero-rated goods, where standard accounting may produce a repayment
Making Tax Digital still applies
The Flat Rate Scheme does not exempt you from Making Tax Digital for VAT. You must still keep digital records and file through compatible software, normally every quarter. See our VAT guide and our checklist for Making Tax Digital for VAT.
How to switch or leave
You apply to join through HMRC, or by ticking the box when registering for VAT. You can leave at any time by writing to HMRC, and must leave if you exceed the limits. After leaving, you cannot rejoin for 12 months. Review your position at least annually.
Bookkeeping under the scheme
Even on the flat rate, you still need to:
- Issue proper VAT invoices showing the normal VAT
- Record gross turnover by period
- Keep purchase records for income tax purposes
- Reconcile the VAT account to your return
- Test every year whether you are still a limited cost trader
Our VAT-ready bookkeeping handles the calculations and checks, and we can model both schemes with your actual numbers.
Contractors and the flat rate
Many contractors used the scheme heavily before the limited cost trader rule, and some still do if they have genuine costs. See bookkeeping for IT contractors and freelancers. Our director salary and dividend calculator can help with the broader picture of what you take home.
Questions to ask yourself
- What is my expected turnover for the next 12 months?
- What do I spend on goods, excluding capital items?
- Am I a limited cost trader?
- What is my flat rate, and is it lower than my effective standard rate?
- Am I in my first year?
- Would I rather have simplicity or the lowest bill?
How to decide in fifteen minutes
Take your last four VAT quarters. Work out what you actually paid HMRC under standard accounting. Then recalculate each quarter as if you had used the flat rate, multiplying your VAT-inclusive turnover by your flat rate percentage, remembering the 16.5% rate if you are a limited cost trader. Add up the difference. If the flat rate would have saved you money and the saving is meaningful, consider joining. If it would have cost you more, or the saving is tiny, stay on standard accounting. Repeat the exercise each year, because your costs and turnover change. Our bookkeeping service can run the comparison for you using your real figures.
Frequently asked questions
What is the flat rate percentage for my business?
It depends on your trade sector. HMRC publishes the full list. Limited cost traders pay 16.5% regardless.
Can I reclaim VAT on purchases under the scheme?
Generally no, except for capital assets costing £2,000 or more including VAT.
How do I know if I am a limited cost trader?
If your spend on relevant goods is under 2% of your VAT-inclusive turnover, or under £1,000 a year if higher, you are a limited cost trader.
Is the Flat Rate Scheme compulsory?
No. It is optional, and you can leave at any time.
Can you work out which scheme is cheaper for me?
Yes. Send us your figures and we will model both. Get an instant quote or ask for a free health check.
This article is general information, not personal tax or financial advice. Rules and rates change, so check GOV.UK or speak to an accountant about your circumstances. Rates shown are for 2026/27, last checked November 2026.
Written by The Bookkeeping Services team
Bookkeeping Services is run by Accotax London Limited, an ICAEW regulated firm with ACCA and AAT qualified people. Our guides are reviewed against GOV.UK and HMRC guidance before publishing and updated when the rules change.
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