The flat rate VAT scheme for small businesses can save you a lot of time each quarter when it comes to completing your VAT return. However this saving must be balanced against the risk of falling into the trap of paying too much or too little VAT.
When you first register for the flat rate VAT scheme you need to choose a trade sector which best fits the activities of your business. There are about 90 descriptions of trade sectors and 16 different flat rates that apply to these sectors. If you do not select the correct trade sector for your business you will not pay the right amount of VAT. This can lead to interest and penalties.
Unfortunately there is little guidance available about what each trade sector covers. There is a ‘ready reckoner’ on the HMRC website but if you enter a term it does not recognise, such as ‘child minding’, it unhelpfully says ‘no match found’.
The trade sectors and flat rates change occasionally. The last alteration was effective from 1 April 2004 but HMRC does not write to businesses to let them know. You are expected to check the latest guidance on the HMRC website, which is not always easy to find. You leave yourself open to VAT penalties if you use an old flat rate after it has subsequently been amended.
A common mistake is to apply the flat rate to your sales net of the VAT charged to customers. The flat rate scheme does not affect the amount of VAT you charge to each customer. You will still charge the VAT due on the sales invoices you send your clients, at the normal 17.5%, 5% or zero rates. The VAT you pay to HMRC, however, is calculated by multiplying your total supplies, including exempt supplies like rent, by the flat rate appropriate to your trade sector.
The flat rate scheme ignores your purchases for VAT purposes. If your supplies change, for example, you buy more expensive materials, it may be advisable to come out of the flat rate VAT scheme. You will then revert to reclaiming the VAT on your purchases against the VAT charged on your sales.
This is a complicated area and your VAT position needs to be reviewed regularly. Please contact us if you would like to discuss this further.