UK VAT schemes: a guide to VAT accounting methods

Understanding VAT is an important part of running a business in the UK. 

If you have registered your business for VAT, you may have the opportunity to decide whether a specialist HMRC VAT scheme could make managing your tax obligations simpler for your business. 

Your choice of VAT scheme can affect your cash flow, record-keeping requirements, and administrative workload. Whilst some businesses benefit from simplified options such as the VAT Flat Rate Scheme, others may be better suited to Standard VAT accounting. 

In our guide below, created in collaboration with Markel Tax, learn more about the main UK VAT schemes available, eligibility criteria, and the advantages and disadvantages of each. 

What is VAT? 

Value Added Tax (VAT) is a tax charged on most goods and services sold in the UK. VAT-registered businesses add VAT to the goods or services they sell, while reclaiming VAT paid on eligible business purchases. 

To understand more about VAT and the registration process, you can visit Markel Direct’s VAT guide. 

UK VAT schemes 

HMRC offers several different VAT accounting schemes to help businesses manage their VAT obligations, including: 

• Standard VAT accounting 
• VAT Flat Rate Scheme 
• VAT Cash Accounting Scheme 
• VAT Annual Accounting Scheme 

The most suitable option depends on a range of factors, including your turnover, industry, expenses, and cash flow requirements. 

Standard VAT accounting 

Standard VAT accounting is the default method for how most VAT-registered businesses account for VAT. Under this scheme, you charge VAT on sales, reclaim VAT on eligible purchases, and pay HMRC the difference between the two amounts. 

The standard VAT rate for most goods and services is 20%, although some goods and services are subject to reduced rates or zero rates depending on HMRC’s rules. 

Standard VAT accounting eligibility criteria 

Any VAT-registered business can use Standard VAT accounting. 

Advantages of Standard VAT accounting 

• Full VAT recovery on eligible business expenses 
• Suitable for businesses with higher operating costs 
• No specialist scheme restrictions 
• Provides an accurate calculation of VAT owed 

Disadvantages of Standard VAT accounting 

• More detailed record-keeping requirements 
• Quarterly VAT returns are typically required 
• VAT may become payable before customers have paid invoices 
• More administration compared to simplified VAT accounting methods 

Flat Rate Scheme 

The VAT Flat Rate Scheme is designed to simplify VAT accounting for smaller businesses. Instead of calculating the difference between VAT chargeable on sales and VAT paid and recoverable on purchases, businesses pay HMRC a fixed percentage of their VAT-inclusive turnover. 

The VAT percentage for this scheme depends on the type of business and industry sector – visit GOV.UK for a full list of the respective percentages. 

Flat Rate Scheme eligibility criteria 

Businesses may be able to join the VAT Flat Rate Scheme if their VAT turnover is £150,000 or less, excluding VAT. To join FRS, you must get agreement from HMRC using form VAT600FRS. 

Advantages of the Flat Rate Scheme 

• Simpler VAT calculations and record-keeping 
• Less administrative time spent preparing VAT returns 
• Predictable VAT payments 
• Some businesses may pay less VAT than under Standard VAT accounting 
• A 1% discount may apply during the first year of VAT registration 

Disadvantages of the Flat Rate Scheme 

• You generally cannot reclaim VAT on most business purchases 
• The scheme may not be cost-effective if you have significant expenses 
• Some businesses are subject to limited cost trader rules, which may reduce any benefit 
• Certain businesses may pay more VAT than they would under Standard VAT accounting 

Cash Accounting Scheme 

The VAT Cash Accounting Scheme impacts when VAT is accounted for as it allows businesses to pay VAT on sales when customers pay and reclaim VAT on purchases when a business has paid their supplier. This scheme uses the same VAT rates as Standard VAT accounting – 20% for most goods and services. 

Cash Accounting Scheme eligibility criteria 

Businesses with annual VAT taxable turnover of £1.35 million or less may be eligible for the Cash Accounting Scheme. 

Advantages of the Cash Accounting Scheme 

• Can improve cash flow 
• Useful for businesses that experience late customer payments 
• You do not pay VAT before receiving payment from customers 
• May make VAT liabilities easier to manage 

Disadvantages of the Cash Accounting Scheme 

• VAT on purchases can only be reclaimed after suppliers have been paid 
• May not benefit businesses that receive payment quickly 
• Requires careful payment tracking 
• Not suitable for all business models 

Annual Accounting Scheme 

The VAT Annual Accounting Scheme also impacts when VAT is accounted for as it allows businesses to submit one VAT return each year, instead of four quarterly returns, and make advance payments towards their expected VAT bill during the year. This scheme also uses the same VAT rates as Standard VAT accounting – 20% for most goods and services. 

Annual Accounting Scheme eligibility criteria 

Businesses with annual VAT taxable turnover of £1.35 million or less may qualify for the Annual Accounting Scheme. To join Annual Accounting, you must get agreement from HMRC using form VAT600AA. 

Advantages of the Annual Accounting Scheme 

• One VAT return per year instead of quarterly returns 
• Reduced administrative workload 
• Easier budgeting through regular advance payments 
• Can help simplify VAT management 

Disadvantages of the Annual Accounting Scheme 

• Advance payments must still be made throughout the year 
• A balancing payment may be due when the annual return is submitted 
• Businesses must estimate VAT liabilities accurately 
• Less regular review of VAT records could increase the risk of errors 

Combining schemes 

Some VAT schemes can be used together – for example, HMRC allows businesses using Standard VAT accounting to combine it with either the Cash Accounting Scheme or the Annual Accounting Scheme where eligibility criteria are met. 

However, not all schemes are compatible, as the VAT Flat Rate Scheme has separate rules and should be assessed independently. 

If you are considering combining VAT schemes, check the latest HMRC guidance or seek professional advice. 

How to choose the right VAT scheme 

Choosing the right VAT scheme can be particularly important for contractors, freelancers, and small business owners, as it can affect both cash flow and administrative workload. 

The most suitable option will depend on factors such as your turnover, business expenses, cash flow requirements, and the amount of time you are willing to spend on VAT administration. 

Before choosing a VAT scheme, it is important to review the latest HMRC eligibility criteria and consider seeking advice from a qualified accountant or tax professional. 

Frequently asked questions about VAT schemes 

Which VAT scheme is best for small businesses? 

There is no single best VAT scheme for small businesses. The right option depends on factors such as annual turnover, industry sector, business expenses, cash flow requirements, and administrative preferences. 

Can you claim VAT back on a Flat Rate Scheme? 

In most cases, businesses using the VAT Flat Rate Scheme cannot reclaim VAT on routine purchases and expenses. However, there are limited exceptions for certain capital assets that meet HMRC’s criteria. 

How do I know what VAT scheme I am on? 

You can usually check your VAT accounting method through your HMRC Business Tax Account, your VAT registration records, or by speaking with your accountant. 

How do I change VAT scheme? 

Businesses can usually apply to join or leave a VAT scheme through HMRC, provided they meet the relevant eligibility criteria. The specific process varies depending on the scheme, so it is worth reviewing the latest HMRC guidance and consulting a qualified professional before making any changes. 

What is a VAT margin scheme? 

A VAT Margin Scheme is a specialist scheme available for certain businesses, including some that sell second-hand goods. Instead of paying VAT on the full selling price, VAT is calculated on the difference between the purchase price and the selling price, often referred to as the margin.  

How do you calculate VAT on a flat rate? 

Under the VAT Flat Rate Scheme, you apply your HMRC-assigned flat rate percentage to your VAT-inclusive turnover. For example, if your VAT-inclusive turnover for a period is £10,000 and your flat rate percentage is 12%, the VAT due to HMRC would be: £10,000 × 12% = £1,200 

The percentage used depends on your business sector and should be verified using HMRC’s latest flat rate tables or consulting a qualified professional. 

Discover our knowledge centre for more help and guidance or read more about Caunce O’Hara’s contractor insurance. 

Please note: This article provides guidance for information purposes only and is accurate at the time of production. It should not be relied upon wholly when making or taking important business decisions – always seek the services of an appropriately qualified professional for personalised tax or legal advice. The views expressed by websites referenced to are limited to those of the websites, and do not necessarily reflect the views of Caunce O’Hara. Caunce O’Hara is not affiliated with any of the brands, companies or websites mentioned in this article.