We often get asked the question: can I go on the Flat Rate VAT Scheme? The answer for most contractors used to be a straight-forward: yes. Now, however, it’s not quite that simple.
If you’re a contractor with limited outgoing expenses, you are likely to be classed as a ‘limited cost trader’ which makes the Flat Rate Scheme less attractive. VAT is a big topic – here, we summarise what you need to know
Do you have to be VAT registered?
No, it’s not compulsory until your annual turnover reaches, or is expected to reach, £85,000. However, lots of contractors choose to become VAT registered, even when their earnings are not at the threshold, as it can send the message to clients that you are a credible professional. In many cases, clients are used to paying VAT for the services they commission and can reclaim the VAT paid over to your business, so do not quibble the inclusion of VAT on contractor invoices.
Types of VAT
There are two types of VAT scheme which are relevant to most contractors – Standard Rate and Flat Rate.
- With the Standard Rate, you add a 20% VAT charge to each invoice you issue and pass this on to HMRC, minus the VAT you’ve paid on allowable business expenses.
- The Flat Rate VAT scheme, on the other hand, involves charging your clients VAT at the Standard Rate of 20% but passing on a smaller amount to HMRC. As a member of the Flat Rate VAT scheme, you don’t claim back the VAT you’ve paid on expenses (apart from certain capital purchases over £2,000). Instead, you keep the difference in the VAT you charge and the amount you hand over to HMRC. The amount of VAT you have to pass on to HMRC is determined by your industry type, though you are allowed to apply a 1% discount in the first year.
Flat Rate Scheme eligibility
To join the Flat Rate scheme, your VAT turnover must be £150,000 or less. VAT taxable turnover is your total sales excluding anything which may be VAT exempt.
You would have to leave the scheme if your turnover was more than £230,000, including VAT. You can start out on the Flat Rate scheme and switch to the Standard Rate if your circumstances change or you find you would be better off claiming back the VAT on your purchases.
Limited Cost Trader test
The Flat Rate VAT scheme was designed to simplify VAT for small businesses – it saves small business owners the admin headache in working out what VAT has been paid on purchases vs what VAT has been charged to clients.
For contractors, Flat Rate VAT is complicated by what is known as the Limited Cost Trader Test. This test is applicable to many labour-only businesses, like PSCs or limited company contractors. If you are a Limited Cost Trader, your goods cost less than either:
- 2% of your turnover
- £1,000 a year (if your costs are more than 2%)
As Limited Cost Trader, you have to pay 16.5% flat rate VAT, regardless of what industry category you fall into, which means that the difference between the Flat Rate and Standard Rate Schemes is negligible.
Example – Limited Cost Trader
You invoice your client £100 + VAT, so the total invoice value is £120.00.
You pay 16.5% VAT on the gross value of the invoice (16.5% of £120.00) which is £19.80.
Example – Standard Rate VAT
You invoice your client £100 + VAT, so the total invoice value is £120.00
You pass on the VAT part of the invoice to HMRC, which is £20.
If you wish to look at whether joining the Flat Rate Scheme would be right for you, please talk first to one of our specialist contractor accountants who will be able to provide tailored calculations and advise you on the best approach.
Registering for VAT
Registering for VAT is a relatively straight-forward process which you can do online, or we can do on your behalf. Once you are registered, you will receive a VAT registration certificate which includes your ‘effective date of registration’ which is either the date you went over the threshold or the date you requested. You cannot charge or show VAT on your invoices until you receive your VAT number, though you’ll still have to pay the VAT to HMRC for the period covered by your VAT registration.
If you become VAT registered, you will need to file a VAT return each quarter, otherwise you will incur a penalty from HMRC. Completing your VAT return is quick and simple to do if you’re a client of JSA as you will have access to FreeAgent accounting software when you join us. FreeAgent will automatically generate your VAT return and we’ll send you a notification when it is ready to review – you simply check it, approve it when happy and confirm to us that it can be submitted to HMRC.
What to do next
Please get in touch with a member of our team who will be pleased to answer any questions you may have about VAT and contracting. If you do not already have a contractor accountant who can provide specialist advice, let us help you with ongoing support. We provide accountancy services to thousands of contractors just like you. With JSA, you get unlimited, tailored support, and FreeAgent online accounting software is included as standard.