Categorized | flat rate vat scheme, VAT

The flat rate vat scheme for freelance contractors

The flat rate vat scheme for freelance contractors

In 2002, HMRC introduced the Flat Rate Scheme (FRS) for small businesses. Its primary aim is to greatly simplify the calculation of VAT by removing the need to account for VAT on all the items that pass through your business and so improve both accuracy and compliance.

FRS allows you to charge VAT to your clients at the prevailing rate but pay a lump sum to HMRC at a lower flat rate. There are different rates for various types of business, but for most IT contractors and similar, the prevailing rates at the time of writing are 15% and 11.5% respectively. (Note that these will change in January 2010 when VAT returns to 17.5%. The repayment rate was previously 13%, but the Chancellor has hinted he may revise this rate, presumably to something less advantageous).

The advantages are obvious. Calculation of VAT due is simply a straight percentage of your gross turnover. Since you are repaying less that you are charging, you make a small profit. This is liable to Corporation Tax, of course, so is a little less than you may think, but every little helps. If, however, you have a large number of purchases in your line of business, you may lose out overall. If you buy a single item for more than £2000, incidentally, you can reclaim the total amount of VAT paid out for that item separately to your FRS calculation.

You can join the scheme if your annual taxable turnover excluding VAT does not exceed £150,000 pa and your total projected turnover for the next 12 months does not exceed £187,000 (figures correct at the time of writing but may change).  You can leave the scheme voluntarily at any time, or if your annual turnover goes over £225,000 pa.

One thing to be careful of is when the VAT rates change. You must always apply the correct pair of percentages at the tax point of the invoice. You cannot charge at the old rate and pay back at the new one or vice versa, you must account for the correct amounts either side of the date of the change.

Finally there is an incentive for new joiners. The flat rate is further reduced by 1% for the first year

The simplest way to join the scheme is to phone the VAT Helpline at HMRC on 0845 01 9000 and they will put the wheels in motion, or you can download an application form from HMRC.

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