The VAT Flat Rate Scheme is supposed to make life simpler for small businesses. Instead of tracking VAT on every purchase and sale, you pay HMRC a fixed percentage of your gross turnover. For some businesses, it saves time and money. For others — particularly since the “limited cost trader” rules arrived in 2017 — it’s barely worth the paper the registration is printed on.
How It Works
Under standard VAT accounting, you charge 20% on sales and reclaim the VAT on purchases. The difference goes to HMRC. Under the Flat Rate Scheme (FRS), you still charge customers 20%, but instead of all that input/output tracking, you pay HMRC a flat percentage of your total gross income (including the VAT you charged).
The percentage varies by trade. Some examples for 2025/26:
- IT consultancy: 14.5%
- Management consultancy: 14%
- Hairdressing and beauty: 13%
- Plumbing and heating: 9.5%
- Building and construction: 9.5%
- Food retail: 4%
- Accountancy: 14.5%
New businesses get 1% off in their first year. Nice touch.
When the FRS Saves You Money
The scheme works when the gap between the VAT you charge (20%) and the flat rate you pay is bigger than the VAT you’d actually reclaim on purchases. Take an IT consultant on 14.5%:
- Invoice: £1,000 + £200 VAT = £1,200
- FRS to HMRC: £1,200 × 14.5% = £174
- VAT kept: £200 − £174 = £26
If you spend less than £26 in VAT on purchases per £1,000 of sales, the FRS saves money. For service businesses with low overheads, that’s often the case.
The Limited Cost Trader Problem
In April 2017, HMRC plugged the gap with the “limited cost trader” rule. If your VAT-inclusive spending on goods (not services) is less than 2% of gross turnover, or less than £1,000/year (whichever is bigger), you’re a limited cost trader. Your flat rate? 16.5%. Regardless of your trade.
At 16.5%, the scheme is basically pointless:
- Invoice: £1,200 (inc. VAT). FRS at 16.5% = £198. You keep £2.
Two pounds. Most labour-only service businesses (consultants, freelance developers, copywriters) fall into this category because they barely buy physical goods. If you’re a limited cost trader, standard VAT accounting is almost always better.
What Counts as “Goods”?
Only spending on physical goods counts towards the 2% test. Rent, insurance, accountancy fees, software subscriptions — those are services and don’t count. Food and drink, vehicle costs, and capital items over £2,000 are also excluded. This makes it really hard for most service businesses to escape limited cost trader status.
Joining and Leaving
You can join if your VAT-exclusive turnover is £150,000 or less. You must leave if your total income exceeds £230,000 in the previous 12 months. You can leave voluntarily at any time with 30 days’ notice.
When you leave, you switch to standard VAT accounting. There’s no clawback of any benefit you received while on the scheme, so there’s no downside to trying it and leaving if it doesn’t work out.
Should You Join?
The FRS is worth a look if you’re in a trade with a low flat rate percentage and you buy physical goods regularly (builders, caterers, retailers). For labour-only service businesses, it’s rarely worthwhile after the limited cost trader rules. Run the numbers for your specific situation using our free VAT calculator.