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How does VAT work?

You have to register for VAT if you are over the limit which is £85,000.  If you take over an existing trade, their trade counts towards the limit.  The limit is calculated on a rolling year.

You prepare a VAT return each quarter, telling the Revenue what your sales and purchases are.

This is how normal VAT works:

You make sales and purchases:



In this example £8,000 goes to HMRC, but you collect £10,000 from your customers. So if your customers are VAT registered you benefit by £2,000 as a result of VAT registration.

Cash accounting. If your turnover is less than £1,350,000 you can join the cash accounting scheme, you only account for your VAT on sales when you receive the money.

Flat rate VAT. Your turnover needs to be less than £150,000. 

This works by multiplying ‘the percentage’ by your gross sales. You could benefit by Flat rate VAT %. So if you have sales of £100,000 as a management consultant, you would charge £20,000 in VAT and under flat rate pay the Revenue £120,000 x (for example 14%) = £16,800, a profit of £3,200. 

New Flat Rate VAT Scheme

From 1 April 2017 a new category of trader, a ‘limited cost trader’, with a Flat Rate Scheme (FRS) percentage of 16.5% applies to FRS users.

This measure was introduced to counter widescale abusive behaviour involving agency workers.

  • A business within the FRS will have to consider for each VAT accounting period whether it is a limited cost trader.
  • If you are a limited cost trader, your FRS percentage will be 16.5% regardless of your business sector.
  • The 1% reduction for the first year of VAT registration applies as normal, making the rate 15.5% for newly registered business caught by the new rules.
  • The measure may make the FRS less attractive for service businesses, e.g. such as IT, consulting and accountancy.
  • HMRC says that the FRS was being abused by employment agencies and advisers.

Who is a limited cost trader?

A business is a limited cost trader if its VAT inclusive expenditure on goods is:

  • Less than 2% of VAT inclusive turnover, or
  • More than 2% of VAT inclusive turnover, but less than £1,000 per year, or pro-rated for each VAT return period.

'Goods' for these purposes are those used exclusively for business purposes and excluding:

  • Capital expenditure.
  • Food & drink for consumption by the Flat Rate business or its employees.
  • Vehicles, vehicle parts and fuel, unless the business is one which supplies transport services and uses its own or leased vehicles such as a taxi business.
  • Items purchased for re-sale, letting, leasing or hiring out, except where the business is one of selling, letting, leasing or hiring out.
  • Promotional items, e.g. pens to give away or donations.
  • Any services.

The measure is intended to make the FRS less beneficial for low cost businesses that mainly provide personal services, e.g. IT consultants or accountants who incur VAT on services such as rent, software licences, telecoms and so on but not on goods, or labour only providers, e.g. security guards, temps etc.

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