Avoiding the flat rate percentage trap

Avoiding the flat rate percentage trap

​The general flat rate scheme (FRS) reduces the VAT burden for many businesses. However, it’s easy to fall foul of a trap that diminishes the advantages. What is it and how can you avoid it?

​FRS advantages

​HMRC emphasises the possible admin advantages for businesses of using the general VAT flat rate scheme (FRS), e.g. reduced record keeping, but the main reason most business owners adopt the FRS is that it usually reduces their VAT bill. The saving works by charging customers the usual rate of VAT but only accounting for a lower rate (this varies depending on the type of business) to HMRC in their quarterly returns. The quid pro quo is that you generally cannot reclaim VAT paid on purchases.

​Tip. An exception to the general FRS rule means that you’re entitled to reclaim VAT on purchases of equipment and other fixed assets which cost £2,000 (including VAT) or more. This applies to single or multiple items purchased at the same time.

​Trap. Businesses that don’t spend much must use the FRS low-cost trader (LCT) percentage of 16.5% regardless of the type of business they operate. This eliminates all financial gain from using the FRS.

​Being an LCT in practice

​Before you complete each VAT return you must check if you are an LCT. You will be if your total purchases in the VAT quarter didn’t exceed £250 including VAT, or if they are less than 2% of your total VAT-inclusive turnover.

​Example. Sally is a freelance bookkeeper. The FRS percentage for this is 14.5%. Sally’s VAT-inclusive sales for the quarter ended 30 June 2025 are £18,000. Her purchases were £260 including VAT for such items as stationery and software licences.

​Sally is an LCT because although her purchases were greater than £250 including VAT, they are less than 2% of her turnover (£18,000 x 2% = £360). She must apply the LCT percentage of 16.5% (instead of 14.5%) to her turnover for the return. This means she must account for VAT of £2,970. In financial terms Sally would be better off not using the FRS.

​Trap. Your business might be an LCT for some quarterly VAT returns but not others.

​Tip. By planning your purchases it’s possible to escape the LCT trap or reduce the number of VAT returns it applies to. For example, instead of making higher value purchases in one VAT quarter, spread your purchases over the year.

​HMRC’s sneaky LCT rules

​The LCT rules say that you must exclude some types of purchase when working out if the £250/2% threshold is met. For example, unless your business is providing transport, e.g. taxi services, purchases of fuel must be ignored. Similarly excluded are purchases of food and drink. A full list of excluded goods is in HMRC’s VAT Notice 733, para 4.6. You should review this list so that you only include qualifying goods in your calculations.

​Tip. If, despite planning your purchases, you’re an LCT for most VAT returns you’ll be financially better off leaving the FRS. You can do this at any time but you must notify HMRC.

​If in a quarter you make purchases for your business of less than £250 (excluding VAT) or 2% of your VAT-inclusive turnover, you must use the low-cost trader FRS percentage (16.5%). This eliminates all financial advantage from the FRS. Try to spread your purchases to avoid the £250/2% limit. Failing that consider leaving the FRS.