The VAT Flat Rate Scheme: is it worth it?
The Flat Rate Scheme lets you pay HMRC a fixed percentage of your VAT-inclusive turnover instead of accounting for VAT on every sale and purchase. You keep the difference but cannot reclaim VAT on most purchases. It suits businesses with low costs and is usually worse for anyone buying significant goods.
How it works
You charge your customers VAT at 20% as normal. Rather than paying over that 20% less your input VAT, you pay HMRC a flat percentage of your gross, VAT-inclusive turnover.
A consultant on the 14.5% rate invoicing £10,000 plus £2,000 VAT pays HMRC 14.5% of £12,000, which is £1,740, and keeps £260. In exchange they reclaim no input VAT at all, apart from capital assets over £2,000.
There is also a 1% discount in your first year of VAT registration.
The limited cost trader trap
This rule exists specifically to stop the scheme being a windfall for service businesses, and it catches most of them.
If your spend on relevant goods is less than 2% of turnover, or less than £1,000 a year, you are a limited cost trader and must use the 16.5% rate regardless of your sector.
16.5% of gross turnover is almost exactly 19.8% of net, so you hand over nearly all the VAT you charged and reclaim nothing. For most consultants, designers and IT contractors, that is strictly worse than standard VAT.
Critically, "relevant goods" excludes services, rent, phone and broadband, accountancy, food and drink, vehicles and fuel. Software is usually a service. Many service businesses buy almost nothing that counts.
Check this before joining, and check it again each quarter. The test is applied every VAT period, not once.
When it does make sense
| Usually better on Flat Rate | Usually better on standard VAT |
|---|---|
| Service businesses with genuine goods spend above 2% | Limited cost traders stuck on 16.5% |
| Low overheads and few VATable purchases | Businesses buying stock or equipment |
| Customers are consumers who cannot reclaim | Significant subcontractor or materials costs |
| You value the simpler bookkeeping | You want to reclaim VAT on everything |
Joining and leaving
You can join if your VAT-exclusive turnover is expected to be under £150,000 in the next twelve months. You must leave once total turnover exceeds £230,000.
You can leave voluntarily at any time, but you cannot rejoin for twelve months, so it is worth modelling properly rather than switching on a hunch.
This guide is general information, current at 10 November 2026. Tax rules change and depend on your circumstances. Please take advice before acting on it.