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BKL points out that the Flat Rate Scheme can sometimes be useful.

OK: let’s manage expectations: it’s not much, it’s a one-off, and it’s available only to a small group of people in limited circumstances.  It’s to do with the VAT Flat Rate Scheme (“FRS”).

Normally, a VAT-registered business pays over to HMRC the difference between the VAT it charges on “outputs” (roughly, sales) and the VAT that it suffers on “inputs” (purchases and costs).  However, if the turnover is small enough (broadly, less than £150,000 plus VAT) HMRC allow you, if you wish, to dispense with the faff of working out the VAT you’ve charged and the VAT you’ve suffered and instead simply pay over to them a percentage (the “flat rate”) of your VAT-inclusive turnover. 

The “flat rate” you pay depends (with one important exception) on the business sector in which you fall – there are about four dozen to choose from – and is designed to ensure that the tax you pay under the FRS approximates to the tax you would pay under the normal scheme.

The exception to the sector “flat rates” is where you are a “limited cost trader”.  Essentially, this means failing to spend more than a small amount on goods: and we do mean “goods” – for some reason services you buy are not taken into account for this purpose.  The de minimis figure is the higher of £250 per quarterly return and 2% of turnover.  Where this is the case, your “flat rate” is 16.5% regardless of your business sector.  Since the “flat rate” is applied to the VAT-inclusive turnover, being on the FRS as a limited cost trader has the same arithmetic effect (to within a few pounds) as being on the normal scheme and recovering no input tax at all – which is of course the intended effect.

Beware of FRS if you are a limited cost trader but your costs include services – in that case the FRS will mean that your VAT payments will be higher than if you are on the normal scheme.  That’s not to say that you should rule out the FRS altogether – it will still simplify your VAT accounting – but be aware that you will paying a price for it.

So, where’s this “free money” then?  Well, under the FRS, you get a 1% reduction in your flat rate percentage for your first year of VAT registration. This means you can take 1% off the flat rate you apply to your turnover, until the day before your first anniversary of becoming VAT registered.  (Note that the entitlement to apply the reduction runs for the 12 months following the date of registration for VAT and not the date you join the FRS.)  In particular, the flat rate for a limited cost trader becomes 15.5%.

Consider what this means for a person setting up a new consultancy business that has never before been registered and which has little or no input tax.  On a VAT-exclusive turnover of £150,000 (the maximum possible under the FRS) the business can either register for VAT in the normal way, charging customers VAT of £30,000 and paying virtually all of it over to HMRC; or it can register for the FRS and pay HMRC 15.5% of the VAT-inclusive turnover – so £27,900. 

Of course, for the reasons above, coming out of the FRS after a year when the rate reverts to 16.5% may be desirable: but the first-year one-off boost is not to be sneezed at.