Limited Cost Trader (goods <2% of turnover or <£1,000/yr)
16.5%
15.5%
How the VAT Flat Rate Scheme Works
Under the standard VAT scheme, you calculate VAT on every sale (output tax) and subtract VAT on purchases (input tax), paying the difference to HMRC. This requires detailed record-keeping of all VAT transactions.
Under the Flat Rate Scheme:
You still charge customers the standard VAT rate (20% on standard-rated goods/services).
You pay HMRC a fixed percentage of your VAT-inclusive turnover (not just the VAT element).
The difference between the VAT you collect and what you pay HMRC is yours to keep as additional income.
You cannot usually reclaim input VAT on purchases (except capital assets over £2,000 inc VAT).
Example: An IT consultant charges £10,000 + VAT = £12,000 total. Under FRS at 14.5%, they pay HMRC £12,000 × 14.5% = £1,740. They keep £12,000 - £1,740 = £10,260. Without FRS, they would pay £2,000 VAT - any input VAT reclaimed. If input costs are low, FRS results in a significant saving.
Limited Cost Trader Rules
Important: If you spend less than 2% of your VAT-inclusive turnover on goods (or less than £1,000 per year on goods), you are a Limited Cost Trader and must use the 16.5% flat rate. This applies even if your sector would normally attract a lower rate.
Goods for this test must be used solely for your business, not capital expenditure, food, vehicles, or items for personal use. Services do not count as goods.
Most consultants, IT contractors, and service-based businesses are Limited Cost Traders. At 16.5%, the FRS typically provides little to no benefit over the standard scheme for these businesses.
VAT Registration Thresholds 2025/26
Registration threshold: £90,000 taxable turnover in any 12-month period
Deregistration threshold: £88,000
FRS eligibility: VAT-taxable turnover up to £150,000 (ex-VAT) to join
FRS exit: Must leave if VAT-inclusive turnover exceeds £230,000 in past 12 months
When is the Standard Scheme Better?
The Flat Rate Scheme is beneficial when your VAT-ratable input costs are low relative to your turnover. The standard scheme may be better when:
You have significant VAT-ratable purchases (e.g., materials for manufacturing or construction)
You are a Limited Cost Trader (16.5% rate makes FRS unattractive)
You regularly make large capital purchases and want to reclaim input VAT
You sell a mix of zero-rated and standard-rated goods (complex to manage under FRS)
Your sector flat rate is relatively high and your input VAT costs are moderate
Frequently Asked Questions
What is the VAT Flat Rate Scheme?
The VAT Flat Rate Scheme (FRS) is a simplified VAT accounting method for small businesses. Instead of calculating VAT on every sale and purchase, you pay a fixed percentage of your VAT-inclusive turnover to HMRC. You keep the difference between what you charge customers at 20% and what you pay HMRC under the flat rate.
Who can use the VAT Flat Rate Scheme?
You can join the FRS if your VAT-taxable turnover (excluding VAT) is £150,000 or less per year. You must leave the scheme if your VAT-inclusive turnover exceeds £230,000 in the past 12 months, or if you expect it to in the next 30 days.
What is the Limited Cost Trader flat rate?
If you spend less than 2% of your VAT-inclusive turnover on goods (or less than £1,000 per year on goods), you are a Limited Cost Trader and must use the flat rate of 16.5%. This was introduced to prevent abuse of the FRS by businesses with very low costs, such as most consultants and contractors.
Is there a first-year discount on the Flat Rate Scheme?
Yes. In your first year of VAT registration, you can deduct 1% from your flat rate percentage. For example, if your sector rate is 14.5%, you pay 13.5% in your first year. This discount applies for the first 12 months from your VAT registration date, not from when you join the FRS.
What is the VAT registration threshold for 2025/26?
The VAT registration threshold is £90,000 for 2025/26. You must register for VAT if your VAT-taxable turnover exceeds £90,000 in any 12-month period. The deregistration threshold is £88,000.
When is the standard VAT scheme better than the Flat Rate Scheme?
The standard scheme is better if you have high VAT-ratable costs (e.g., you buy a lot of goods or services with VAT). Under standard VAT you reclaim input VAT on purchases. Under FRS you generally cannot reclaim input VAT. High-cost businesses such as manufacturers often benefit more from the standard scheme.
Can I reclaim VAT on purchases under the Flat Rate Scheme?
Under the FRS, you generally cannot reclaim input VAT on everyday business purchases. However, you can reclaim VAT on single capital assets costing £2,000 or more (VAT-inclusive). The flat rate payment is designed to cover the net VAT position including a simplified allowance for your purchases.
MB
Mustafa Bilgic
UK tax and financial content specialist. FRS rates sourced from HMRC. Registration threshold £90,000. Last reviewed: 20 February 2026.