The Flat Rate VAT Scheme (FRS) is a popular option for small businesses who want to simplify their VAT obligations. Instead of reclaiming VAT on each purchase and paying VAT on each sale, you pay a single fixed percentage of your gross turnover to HMRC. For many small businesses, this offers less admin and more clarity. But it’s important to understand how the scheme works — and when it doesn’t work in your favour.

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What Is the Flat Rate VAT Scheme?

The Flat Rate Scheme allows VAT-registered businesses with turnover under £150,000 (excluding VAT) to pay VAT at a fixed rate based on their industry.
You still charge customers 20% VAT, but you pay HMRC a flat percentage of your VAT-inclusive turnover. The difference is yours to keep.

For example, if your flat rate is 12%, and you invoice £1,000 + VAT:

• You charge £1,200
• You pay HMRC £144 (12%)
• You keep the difference

This can benefit businesses with low VATable expenses.

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Limited Cost Trader – The Important Catch

If your business spends very little on goods, HMRC classes you as a Limited Cost Trader, and your flat rate jumps to 16.5%.

You are a Limited Cost Trader if your spending on goods is:

• Less than 2% of your VAT-inclusive turnover, or
• Less than £1,000 per year

Goods do not include:

• Rent
• Software
• Fuel
• Phones
• Capital items
• Food or drinks
• Accountancy or marketing costs

This rule makes the scheme far less beneficial for many service-based businesses.

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Pros of the Flat Rate Scheme

✔ Simple and predictable VAT payments
✔ Less bookkeeping
✔ Often financially beneficial in the first year
✔ No need to track input VAT on most purchases

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Cons of the Flat Rate Scheme

✘ Limited Cost Trader rate can remove any benefit
✘ You cannot reclaim VAT on most purchases
✘ Not suitable for businesses with high running costs
✘ Not ideal if you buy a lot of VAT-inclusive goods

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Who Should Use the Flat Rate Scheme

FRS usually works best for:

• Freelancers
• Contractors
• Consultants
• Creative service providers
• Professionals with low overheads

It becomes less attractive if you:

• Run a product-based business
• Have high VAT-able expenses
• Buy equipment frequently
• Fall under the Limited Cost Trader rules

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Should You Join or Leave the Scheme?

Choosing the Flat Rate Scheme depends on your industry rate and your cost pattern.
A proper review can show whether it saves you money or costs you more.
At Taxes Done Right, we regularly review this for clients to ensure they’re on the most tax-efficient setup.

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Final Thoughts

The Flat Rate VAT Scheme can be a smart, simple option for many small businesses — but only when the numbers work. With Limited Cost Trader rules catching out thousands of business owners each year, it’s essential to check whether the scheme is still right for you.

If you’re unsure, we can review your VAT setup and make sure everything is done right from day one.