How to choose the right VAT scheme for your business

No matter whether you run your business as a sole trader or a limited company , it becomes mandatory for you to register for VAT once you reach the annual £90,000 taxable turnover threshold. Many people will choose to voluntarily register for VAT, even if they do not foresee reaching the threshold soon because it can be a strong strategic decision for the business. If you are registering for VAT for the first time, then ensure you understand how to choose the right VAT scheme for your business.

When registering for VAT, you will be given the option to choose which VAT scheme you would like to use. Choosing the right VAT scheme for your business is important as this determines how you calculate your VAT return and how often you will need to file it with HMRC. By choosing the most suitable VAT scheme for your business, you can benefit from having better control over your cashflow.

Find out about the most common VAT schemes used by small businesses and learn how to choose the right scheme for your business.

Standard VAT scheme

The standard VAT scheme, also referred to as the accrual VAT scheme, is the one which is automatically set as the default option when you first register for VAT with HMRC. It is very straight forward, and the VAT owed to HMRC is calculated by deducting VAT invoiced sales from VAT invoiced purchases. Where the total amount after calculation is positive, this amount is due to HMRC, but where the total amount after calculation is negative, this means you are due a VAT refund from HMRC. The standard VAT scheme is completed on a quarterly basis. 

This VAT scheme gives you some degree of flexibility and control over your cashflow between quarters. If you find that you have made a lot of sales, but have not made many purchases, you can stagger some of your sale invoices to fall into the following quarter. By doing this, you can defer VAT payments into the next quarter where you may be likely to make more purchases and therefore minimise your VAT payments.

Cash accounting VAT scheme

The cash accounting VAT scheme is not a different scheme, but an alternative way to calculating VAT to the standard VAT scheme. You do not need to inform HMRC if you want to change to this scheme, but you must remain consistent with whichever method you choose to use. By choosing the cash accounting VAT scheme, you calculate VAT only when sales invoices are paid to you and when you have paid purchase invoices. The difference is therefore when cash has been received and paid as opposed to simply when invoices have been issued and received. In the same way as the Standard VAT scheme, you will have to file a VAT return every quarter.

To use the cash accounting VAT scheme, you must have an annual turnover of less than £1.35 million net to be eligible. However, if you are already using the flat rate scheme, are behind on your VAT returns, or have committed any VAT offences in the previous year, you will be unable to switch to using this scheme. 

The main benefit to using this scheme compared to the standard VAT scheme is that it offers relief from bad debts. As you only calculate VAT on payments received, it means that if a client or customer is late paying you (or does not pay you at all), you are not obligated to include the amount in your VAT calculation.

VAT annual accounting scheme

The VAT annual accounting scheme is one which allows you to only have to file a VAT return once a year, as opposed to quarterly as with the standard VAT scheme or cash accounting VAT scheme. If you want to use this annual scheme, you will need to apply to do so using the form VAT600 AA. You can also choose to use the VAT annual accounting scheme in combination with the flat rate scheme (which will be explained below).

Even though you will not have to submit as many VAT returns throughout the year, you will still have to make regular VAT payments to HMRC. The amount is determined either by an estimate if it is the first year where you are VAT registered or based on your previous year’s VAT return bill. You can choose to make either 9 monthly paid instalments of 10% (of your previous year’s bill or first year’s estimate) which needs to be paid from the end of the 4^th month of your accounting period until the 12^th month, or 3 instalments of 25% (of your previous year’s bill or first year’s estimate). Any outstanding balance that may be owed after these instalments must be paid in full 2 months after the year end together with the VAT return submission. If you have overpaid VAT, you will need to apply for a VAT refund once you have submitted the VAT return.

Only those entities with a taxable turnover of less than £1.35 million in the following 12-month period can use the annual accounting VAT scheme. If you are already enrolled onto this scheme, then you will be able to continue using it up until you reach a taxable turnover of £1.6 million. However, HMRC may expel you from this scheme where you fail to submit your VAT return by the due date of 2 months after your year end or if you fail to make payments on time without reasonable excuse.

The VAT annual accounting scheme was designed to help small businesses by reducing the amount of paperwork that needed to be completed throughout the year. Another benefit to the scheme is that payments are known in advance and can be spread monthly throughout the year.

VAT flat rate scheme

When you use the VAT flat rate scheme, you continue to charge VAT at the appropriate VAT rate for your products or services and pay any VAT charged to you on purchases you make. However, when it comes to calculating how much VAT is due to HMRC, you do not use the standard VAT scheme method or cash accounting VAT scheme method. Instead, you simply need to apply a fixed rate percentage (which is dependent upon your industry and is set by HMRC) on your total taxable turnover for the financial year. To use this scheme you must apply using form VAT600 FRS. If you choose this VAT scheme in your first year of being VAT registered, you are eligible for a 1% discount on your flat rate.

From 1 April 2017, HMRC began a new flat rate of 16.5% for ‘limited cost businesses’. These are businesses which may spend very little on goods and services, and therefore do not pay much VAT, but may collect large sums of VAT from selling their own goods and services. It was therefore introduced to prevent businesses from profiting from being VAT registered as that was not HMRC’s intention. You will fall into this category if you spend under 2% of your turnover on goods and services, or no more than £1,000 per year if your businesses’ expenses are over 2% of your turnover. Although you may end up paying slightly more in VAT by using this VAT scheme, you may see it as worthwhile considering the time it will save you in bookkeeping for your VAT return.

To be able to use this scheme, your business must have an annual turnover of less than £150,000. You will not be able to join the flat rate scheme if you have joined (or were eligible to join) a VAT group in the last 24 months, committed a VAT offence in the last 12 months such as filing or paying late, or are closely affiliated with another business.

The flat rate scheme can help small businesses save on VAT as the fixed rates are lower than the standard 20% VAT rate. However, one drawback is that you are unable to claim back on VAT payments as you would be able to do with other VAT schemes unless you have purchased a capital asset that costs over £2,000 including VAT.

Get help with your VAT returns

These are only some of the most popular VAT schemes for small businesses, but you may also want to find out more about specialist VAT schemes for specific industries. If you’re still unsure about which VAT scheme to use or how to complete your VAT returns, please feel free to call for a consultation to discuss how we can help you with our VAT return service.