Once your business is registered for VAT, you need to choose how you account for it. The scheme you pick affects when you pay VAT, how much paperwork you do and sometimes how much VAT you pay.
This guide compares the four main VAT schemes — standard accounting, the Flat Rate Scheme, cash accounting and annual accounting — so you can see which one suits your business.
What Is VAT?
VAT — Value Added Tax — is a tax charged on most goods and services sold in the UK. A VAT-registered business charges VAT on its sales, reclaims VAT on its purchases, and pays the difference to HMRC. For a full introduction, see this guide to what is VAT.
Businesses must register when their taxable turnover exceeds £90,000 in a rolling 12-month period — see our guide to the VAT registration threshold.
The Standard Accounting Scheme
Standard accounting is the default scheme. You account for VAT on your sales when you issue an invoice, and reclaim VAT on your purchases when you receive a supplier’s invoice — regardless of when the money actually changes hands. Of the VAT schemes, standard accounting is the one most businesses start with.
You submit a VAT return each quarter, and the return is due one calendar month and seven days after the end of the quarter. The standard scheme suits most businesses, especially those that buy a lot of VATable goods and services, because you reclaim the VAT on your purchases in full.
The drawback is cash flow: you may have to pay VAT to HMRC before your customer has paid you — our cash flow forecasting guide explains how to plan around that.
The Flat Rate Scheme
Under the Flat Rate Scheme, you pay HMRC a fixed percentage of your VAT-inclusive turnover, instead of accounting for VAT on each sale and purchase. The percentage depends on your business sector — for example, a different rate applies to a retailer than to an IT consultant — and you keep the difference between the VAT you charge your customers and the flat rate you pay.
You can join the scheme if your VAT-exclusive turnover is £150,000 or less, and you must leave it when your turnover exceeds £230,000. These limits apply to the Flat Rate Scheme only — other VAT schemes have their own limits.
The scheme is simple — your return is little more than your turnover multiplied by your percentage — and it suits businesses with few VATable purchases. But if you buy a lot of goods, you may pay more VAT than under the standard scheme, because you cannot reclaim the VAT on most of your purchases.
The 16.5% Limited Cost Rate
There is a catch for low-cost businesses: if your spending on relevant goods is less than 2% of your turnover, or less than £1,000 a year, you are classed as a limited cost trader and must use a flat rate of 16.5%. For many service businesses, that removes most of the benefit — so check the test before you join.
The Cash Accounting Scheme
Under the Cash Accounting Scheme, you account for VAT when money is received or paid, rather than when an invoice is issued. If a customer pays late, you do not pay the VAT until the money arrives — which makes cash flow far easier to manage.
You can join the scheme if your VAT-exclusive taxable turnover is £1.35 million or less, and you must leave it if your turnover exceeds £1.6 million. The scheme suits businesses that give credit to their customers and sometimes wait to be paid, such as trades and professional services.
One thing to watch: you cannot reclaim the VAT on a purchase until you have paid your supplier.
The Annual Accounting Scheme
Under the Annual Accounting Scheme, you submit just one VAT return a year, instead of four quarterly returns. You make advance payments during the year — usually nine monthly payments, or three quarterly payments — and then settle the balance when you submit your annual return.
You can join if your VAT-exclusive taxable turnover is £1.35 million or less, and you must leave if it exceeds £1.6 million. The scheme suits businesses with steady, predictable turnover. It is less suited to seasonal businesses, because the advance payments are based on your previous year’s VAT bill.
Which VAT Schemes Suit Your Business?
| Scheme | Best for | Watch out for |
|---|---|---|
| Standard accounting | Most businesses, especially those with large VATable purchases | You pay VAT before customers pay you |
| Flat Rate | Small businesses with few purchases and simple affairs | The 16.5% limited cost rate; no reclaim on most purchases |
| Cash accounting | Businesses that give credit and are paid late | You reclaim VAT on purchases only once you have paid |
| Annual accounting | Steady businesses wanting one return a year | Advance payments based on last year’s bill |
Switching Schemes
You can switch between schemes, but check the rules before you do. You cannot use the Flat Rate Scheme and the Cash Accounting Scheme together, and leaving a scheme usually takes effect from the start of your next VAT period. Switching is often worth doing when your business changes — for example, when you start buying more stock, or when late payment becomes a regular problem. You can move between VAT schemes, but always check the rules first.
Whatever scheme you use, keep every VAT invoice, receipt and return, and make sure your bookkeeping separates VAT from net amounts. Our bookkeeping basics guide explains what to keep and how long to keep it.
Making Tax Digital for VAT Applies to All Schemes
Whichever scheme you choose, Making Tax Digital for VAT applies: you must keep digital VAT records and submit your returns using compatible software. All four VAT schemes fall under Making Tax Digital for VAT.
Late returns carry penalties, so watch your deadlines — see this guide to VAT return deadlines in the UK.
Frequently Asked Questions
Can I use the Flat Rate Scheme and cash accounting together?
No — you can use one or the other, but not both. The Flat Rate Scheme accounts for VAT on an invoice basis; cash accounting lets you pay VAT when you are paid.
What happens if my turnover grows past the scheme limit?
You must leave the scheme. For the Flat Rate Scheme, the limit is £230,000; for cash accounting and annual accounting, it is £1.6 million. The change usually takes effect from the start of your next VAT period.
Is the Flat Rate Scheme always cheaper?
No. It suits businesses with few VATable purchases, but if you buy a lot of goods, the standard scheme usually works out better, because you reclaim the VAT on your purchases in full.
Do I still have to file quarterly returns under annual accounting?
No. Under the Annual Accounting Scheme, you file one return a year and make advance payments during the year, then settle the balance with your annual return.
How We Can Help
Choosing a VAT scheme is a decision that affects your cash flow and your tax bill, and the right answer depends on your business. Financial Accounting Firm helps VAT-registered businesses choose the right scheme, keep digital records and file returns on time. Find out more about our VAT services or contact us to discuss your VAT position. Comparing VAT schemes before you commit can save you time and money.
This article is general information only and should not be taken as personal tax or financial advice. Tax rules can change, and your position will depend on your own circumstances.
