VAT Flat Rate Scheme (UK)

Who can join, and when you have to leave

Joining is based on a forecast. GOV.UK says you can join if “you expect your VAT taxable turnover to be £150,000 or less (excluding VAT) in the next 12 months.” You apply to HMRC, and Notice 733 lists the businesses that can’t join, including anyone who has left the scheme in the last 12 months. GOV.UK confirms the wait: “After you leave, you must wait 12 months before you can rejoin the scheme.”

Leaving uses a different, VAT-inclusive figure. You must leave if, on the anniversary of joining, “your turnover in the last 12 months was more than £230,000 (including VAT) - or you expect it to be in the next 12 months,” or if you expect income in the next 30 days alone to pass £230,000. Notice 733 adds a reprieve: if HMRC is satisfied your income in the next 12 months “will not exceed £191,500, you may be eligible to remain in the scheme,” and those figures “include VAT inclusive income of all taxable and exempt supplies.”

The two thresholds don’t line up neatly. £150,000 is measured without VAT and looks forward. £230,000 includes VAT and looks back as well as forward. A business on 20 percent sales with £150,000 of net turnover has £180,000 of VAT-inclusive turnover, well inside the leaving line.

Which percentage you pay

GOV.UK publishes a table of flat rates by trade sector, and you use the one that best describes your business. A few that come up for businesses selling online: “Computer and IT consultancy or data processing” at 14.5 percent, advertising at 11, publishing at 11, management consultancy at 14, and “Business services not listed elsewhere” at 12.

The limited cost business rule overrides the table. Notice 733 says: “If you’re a limited cost business you need to use 16.5%.” You are one if your spending on relevant goods, including VAT, is “less than 2% of your VAT flat rate turnover” or more than 2 percent “but less than £1,000 per year.” For a quarterly return the £1,000 becomes £250. The test runs period by period, so a business can be on 16.5 percent one quarter and its sector rate the next. Relevant goods leave out any services, capital expenditure goods, food or drink for you or your staff, and vehicle costs including fuel outside the transport sector. Notice 733’s own list of things that don’t count includes rent, advertising, accountancy fees, a laptop (capital expenditure) and “software you download, this is a service.” A software business with no stock can easily land on 16.5 percent.

In your first year of VAT registration you take 1 percent off whichever rate applies. Notice 733 is specific that this runs “for the 12 months following the date of registration for VAT and not the date you join the Flat Rate Scheme,” and that you lose it if you registered late.

What you give up on purchases

Normal input VAT recovery stops. GOV.UK says you “cannot reclaim the VAT on your purchases - except for certain capital assets over £2,000.” Notice 733 section 15.2 gives the precise rule: you can reclaim VAT on “a single purchase of capital expenditure goods where the amount of the purchase, including VAT, is £2,000 or more.” Services never qualify, and several smaller purchases can’t be added together.

That is the trade-off to test before joining. Notice 733 warns that because the flat rates are averages, “you may pay more VAT on the Flat Rate Scheme than you would on normal accounting.” A business with heavy VAT-bearing costs usually does better on normal accounting. A business with few costs, which describes many software sellers, may still pay more than under normal accounting once the 16.5 percent rate applies.

Turnover is gross, including what Stripe deducts

The flat rate is applied to VAT-inclusive turnover. GOV.UK: “You calculate the tax you pay by multiplying your VAT flat rate by your ‘VAT inclusive turnover’.” Notice 733 lists a common error on returns: “the VAT exclusive figure is put in box 6, meaning that the flat rate is applied to the net, rather than the gross turnover.”

A Stripe payout is net of Stripe’s fees, so it is the wrong starting figure. Notice 733 section 9.4 says that if you receive a net payment, “you must include the full value before such deductions (and including the relevant VAT) in your scheme turnover.” Its examples are factors and agents rather than payment processors, but the arithmetic is the same: start from what customers paid, which is the charge amount in Stripe, not the payout.

The scheme has its own cash-based turnover method. GOV.UK: “You cannot use the scheme with the Cash Accounting Scheme. Instead, the Flat Rate Scheme has its own cash-based method for calculating turnover.” Under it, a card payment is received “on the date you make out a sales voucher for a credit or debit card payment (not when you actually get paid by the card provider),” which for Stripe means the charge date, not the payout date. Whichever turnover method you choose, Notice 733 says you must use it for at least 12 months.

Supplies outside the scope of UK VAT stay out of flat rate turnover. Notice 733 lists “non-business income and any supplies outside the scope of UK VAT” among the exclusions, so where a sale is taxed in another country, it doesn’t go into the UK flat rate figure.

A worked quarter for a Stripe seller

A UK software company in its second year of VAT registration sells £25,000 of subscriptions in a quarter, all to UK customers, priced exclusive of VAT. Stripe Tax adds 20 percent, so customers pay £30,000 and Stripe reports £5,000 of VAT. The company spends £120 on relevant goods that quarter, under the £250 quarterly line, so it is a limited cost business.

Its flat rate payment is 16.5 percent of £30,000: £4,950. It collected £5,000 of VAT and keeps £50.

Suppose the next quarter it spends £700 on stationery, cleaning products and other office supplies. That passes both 2 percent of £30,000 (£600) and £250, so for that quarter it uses its sector rate instead. If that is the 14.5 percent computer and IT rate, the same £30,000 means a £4,350 payment, and the company keeps £650. Spending £500 would not be enough: it is over £250 but under 2 percent of turnover, and the 16.5 percent rate still applies.

In its first year of registration, the 1 percent reduction would have made the limited cost rate 15.5 percent: £4,650 on the same turnover, keeping £350.

The Flat Rate Scheme in your QuickBooks books

Sales still carry 20 percent VAT, because that is what the customer was charged and what Stripe Tax calculated. So in QuickBooks the sales side looks the same as under normal accounting: net revenue on one side and £5,000 of VAT in the VAT liability account for the quarter in the example.

The gap appears when you pay HMRC. You pay £4,950, and £50 is left in the VAT liability account that nobody is owed. That residue is not a liability. Notice 733 expects scheme accounts to be prepared “using gross receipts, less the flat rate VAT percentage, for turnover,” with expenses including the VAT you couldn’t reclaim. HMRC’s Business Income Manual (BIM31585) shows the same thing in its example: turnover of “£78,960 (£84,000 less £5,040 flat rate VAT).” What you keep is part of turnover and is taxed as profit.

The practical fix is a journal entry each quarter that moves the residue from the VAT liability account to an income account, so the liability account returns to zero after each payment. Purchases are booked gross, with the VAT included in the expense, except for a single capital purchase of £2,000 or more, where the VAT is reclaimed outside the scheme. If the VAT liability account keeps growing quarter after quarter on a business that pays every return in full, an unreleased flat rate surplus is the usual cause.