Most VAT advice online is a decade out of date here. It still tells you the Flat Rate Scheme is a money-maker for consultants and freelancers.
It stopped being one in April 2017, when HMRC introduced the limited cost business rule. If your business buys almost no goods — which describes most service businesses — your flat rate is 16.5%, and there is virtually nothing left in it.
Here is how the four ways of accounting for VAT actually compare, and which one wins for which type of business.
The four options
They are not four versions of the same thing. Each changes something different.
- Standard accounting is the default — VAT falls due by invoice date
- Cash Accounting changes when VAT falls due — payment date, not invoice date
- The Flat Rate Scheme changes how much you pay — a fixed percentage of gross turnover, with no input VAT recovery
- Annual Accounting changes how often you file — one return a year, with payments on account
Annual Accounting combines with either of the other two. The Flat Rate Scheme and Cash Accounting cannot be combined, though the Flat Rate Scheme has its own cash-based turnover method that does something similar.
The comparison
| Standard | Cash Accounting | Flat Rate Scheme | Annual Accounting | |
|---|---|---|---|---|
| What it changes | Nothing — the default | When VAT falls due | How much VAT you pay | How often you file |
| Join if turnover | Any | £1.35 million or less, next 12 months | £150,000 or less excluding VAT, next 12 months | £1.35 million or less, next 12 months |
| Must leave when | — | Turnover over £1.6 million | Total income including VAT over £230,000 for the year to your anniversary, or expected in the next 30 days alone | Turnover over £1.6 million |
| VAT calculated on | Invoice dates | Payment dates | A flat % of VAT-inclusive turnover | Whichever method you use underneath |
| Reclaim input VAT? | Yes | Yes, when you pay the supplier | No — except a single capital purchase of £2,000 or more including VAT | Yes |
| Returns per year | 4 | 4 | 4 | 1, plus instalments |
| Best for | Most businesses; anyone in a repayment position | Businesses paid slowly, or carrying bad debts | Businesses buying real goods with a low sector rate | Businesses wanting predictable cash flow |
| The catch | You pay VAT before your customer pays you | Cannot be used with the Flat Rate Scheme | The limited cost business rule | Only one refund a year |
The limited cost business rule
This is the modern centre of the whole comparison, and most competitor content still skates over it.
You are a limited cost business if your spend on relevant goods, including VAT, is either:
- less than 2% of your VAT-inclusive turnover, or
- more than 2% but less than £1,000 a year (£250 for a quarterly return)
If either applies, your flat rate is 16.5%, regardless of what your trade sector rate says.
The word doing the work is goods. Relevant goods must be moveable items used exclusively for the business. That excludes:
- any services at all — accountancy, advertising, subcontracted labour, software subscriptions, rent, insurance
- capital expenditure goods of any value, including that new laptop
- vehicle costs and fuel, unless you operate in the transport sector
- food and drink for you or your staff
- goods for resale or hire unless that is your main trade, and promotional items, gifts and donations
For a consultant, developer, designer, copywriter or coach, that leaves stationery, business electricity and not much else. Almost all of them are limited cost businesses.
And the test applies every VAT period, not once. A business hovering around the 2% line can be at its sector rate one quarter and 16.5% the next.
Why 16.5% is so close to worthless
The flat rate applies to your VAT-inclusive turnover, not your net sales. So 16.5% of gross is 19.8% of net. You charged 20%.
You keep 0.2% of your net turnover — and you have given up every penny of input VAT recovery to do it.
Worked example one: the IT consultant
Net turnover £80,000, so VAT charged is £16,000 and gross turnover is £96,000. Standard-rated costs run at £6,000 including VAT, almost all services, with relevant goods spend of £600 a year.
£600 is less than 2% of £96,000, so this is a limited cost business.
| Standard accounting | Flat Rate at 16.5% | Flat Rate at the 14.5% sector rate | |
|---|---|---|---|
| Output VAT | £16,000 | — | — |
| Input VAT reclaimed | £1,000 | £0 | £0 |
| Paid to HMRC | £15,000 | £15,840 | £13,920 |
| Difference vs standard | — | £840 worse | £1,080 better |
Computer and IT consultancy carries a 14.5% flat rate. On that rate the scheme would win by over a thousand pounds a year. The limited cost rule takes it away and turns it into a loss.
One exception. In your first year as a VAT-registered business you get a 1% reduction, so a limited cost business pays 15.5% — £14,880 here, £120 better than standard accounting. The discount runs for the 12 months following your VAT registration date, not the date you joined the scheme.
Worked example two: the building contractor
Same net turnover of £80,000 and the same £16,000 of output VAT. But this business buys £18,000 of materials a year including VAT, plus £2,000 of other standard-rated costs.
£18,000 is comfortably over both 2% and £1,000, so this is not a limited cost business. General building or construction services carries a flat rate of 9.5%.
| Standard accounting | Flat Rate at 9.5% | |
|---|---|---|
| Output VAT | £16,000 | — |
| Input VAT reclaimed | £3,333 | £0 |
| Paid to HMRC | £12,667 | £9,120 |
| Difference | — | £3,547 better |
This is the profile the Flat Rate Scheme still suits: real goods spend, a low sector rate, simple bookkeeping. Retailers, food wholesalers, manufacturers, general builders and pubs are all in this territory. Note the trap in construction — labour-only building services carry a 14.5% rate, and a labour-only subcontractor with negligible materials is heading straight for 16.5%.
Worked example three: the agency with slow payers
A design agency turning over £200,000 works on 60-day terms. One client is 90 days late on a £30,000 invoice carrying £6,000 of VAT.
Under standard accounting that £6,000 is payable at the return deadline whether or not the client has paid. Under Cash Accounting it is not due until the money arrives.
Nothing about the total changes. What changes is whether you fund HMRC out of your own working capital while you wait. For any business with long payment terms or bad debt exposure, that is worth more than a percentage point elsewhere. Plan the exit, though: when you leave the scheme you must account for all outstanding VAT whether or not customers have paid, spread over six months if you need it.
Annual Accounting: the cash flow scheme
One return a year, due two months after your accounting period ends, with advance payments in between — monthly instalments of 10% of last year’s bill at the end of months 4 to 12, or quarterly instalments of 25% at the end of months 4, 7 and 10. A balancing payment settles the difference.
It suits businesses that want VAT to be a predictable monthly cost rather than four unpleasant surprises. It does not suit anyone in a regular repayment position, because you only get one refund a year.
How to choose
| Your situation | Likely best fit |
|---|---|
| Service business, minimal goods spend | Standard accounting |
| First year of VAT registration, service business | Run both — the 1% discount can tip it |
| Buys materials, stock or components | Model the Flat Rate Scheme properly |
| Regularly in a repayment position | Standard; avoid Annual Accounting |
| Long payment terms or bad debts | Cash Accounting |
| Wants predictable outgoings | Annual Accounting, layered on top |
When you are forced off the Flat Rate Scheme. Two triggers do it, and only two:
- The anniversary test. At the anniversary of the date you joined, your total income including VAT for the year then ending — excluding sales of capital assets — comes to more than £230,000.
- The 30-day forward look. At any point you have reasonable grounds to believe your total income in the next 30 days alone will exceed £230,000. That one bites immediately, not at the next anniversary.
There is no 12-month forward-looking test, despite how often you will see one quoted.
And there is a concession most articles miss. If you breach the anniversary test but can satisfy HMRC that your total income in the following 12 months will not exceed £191,500, you can apply in writing to stay on the scheme. A business that hits £235,000 on the back of one unusual contract does not automatically have to leave — but it does have to ask.
You can leave the Flat Rate Scheme whenever you like by contacting HMRC, but you must then wait 12 months to rejoin — it is not a switch to flick each year. Cash Accounting needs no application at all: you simply start at the beginning of a VAT period.
Frequently asked questions
Is the Flat Rate Scheme still worth it in 2027?
For businesses buying genuine goods — retailers, manufacturers, general builders, food businesses — often yes. For service businesses with almost no goods spend, the limited cost business rule sets the rate at 16.5% and the scheme usually costs more than standard accounting.
What counts as goods for the limited cost business test?
Moveable items used exclusively for the business: stock, stationery, cleaning products, business gas and electricity, materials. It excludes all services, capital expenditure goods of any value, vehicle costs and fuel outside the transport sector, and food and drink for you or your staff.
Can I use the Flat Rate Scheme and Cash Accounting together?
No. The two schemes cannot be combined. The Flat Rate Scheme has its own cash-based turnover method, which lets you calculate flat rate turnover on payments received rather than invoices raised.
When do I have to leave the Flat Rate Scheme?
There are two triggers. At the anniversary of the date you joined, if your total income including VAT for the year then ending — excluding sales of capital assets — exceeds £230,000. And at any point, if you have reasonable grounds to believe your total income in the next 30 days alone will exceed £230,000. There is no 12-month forward-looking test. If you go over on the anniversary test but can satisfy HMRC that your total income in the next 12 months will not exceed £191,500, you can apply in writing to stay on the scheme.
Can I reclaim any VAT on the Flat Rate Scheme?
Only on a single purchase of capital expenditure goods costing £2,000 or more including VAT. Multiple smaller purchases, purchases under £2,000, and services do not qualify — the input tax on those is already built into your flat rate percentage.
Getting the scheme choice right
Scheme choice is worth a few thousand pounds a year, and it is not a one-off decision — the limited cost test bites every quarter and the thresholds move with your growth.
SmartFiling files MTD VAT returns for a fixed fee and reviews your scheme as part of the work, using Xero, QuickBooks or FreeAgent. Every return is checked by an ICAEW Chartered Accountant before it goes to HMRC.
