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VAT schemes in plain English

Flat rate, cash accounting and annual accounting are three HMRC schemes that make VAT simpler for small businesses. Each solves a different problem.

Tax

In short

Standard VAT means tracking VAT on every sale and cost and filing regular returns. HMRC offers schemes for smaller businesses. Flat Rate simplifies the maths. Cash Accounting times VAT around when money actually moves. Annual Accounting cuts the number of returns. Some can be combined.

How it works

Three columns. Flat rate: pay a fixed percentage of turnover; solves paperwork; can cost more if you have high costs. Cash accounting: pay VAT when customers pay you; solves slow-paying clients. Annual accounting: one return a year with advance instalments; solves admin and smooths payments.
Eligibility limits and rates change. Check GOV.UK before you join one.
  • Flat Rate Scheme: you still charge customers VAT at the normal rate, but you pay HMRC a fixed percentage of your VAT-inclusive turnover. The percentage depends on your type of business. You generally can't reclaim VAT on costs, so it suits businesses with few purchases. There's a special higher rate for businesses that spend very little on goods.
  • Cash Accounting Scheme: you pay VAT when your customer pays you, not when you invoice. It protects you from paying VAT on money you haven't received. It's similar in spirit to cash basis for income tax.
  • Annual Accounting Scheme: one VAT return a year, with advance payments through the year. It helps budgeting and cash flow.

Each scheme has turnover limits for joining and leaving. They're reviewed from time to time.

An example

Lucy, a consultant, has almost no costs and wants simple admin. The Flat Rate Scheme suits her. Marcus, a builder, buys lots of materials, so he'd lose out on the flat rate. He chooses cash accounting instead, because big clients often pay him late.

Common mistakes

  • Joining the flat rate scheme without comparing it to standard VAT using real figures.
  • Not checking the limited-cost business rule.
  • Forgetting to leave a scheme when you outgrow it.

Your next step: take last quarter's figures and work out the VAT you'd pay under standard VAT and under the flat rate. The difference tells you which suits you.