The VAT flat rate scheme is an optional simplified accounting scheme for small businesses. The scheme is available to businesses which are eligible to be registered for VAT and whose taxable turnover (excluding VAT) in the next year will be £150,000 or less. Once in the scheme, a business can remain in it as long as its taxable turnover for the current year is not more than £230,000.

The flat rate scheme is designed to simplify the recording of sales and purchases. Under the scheme, a business works out the VAT that it is required to pay over to HMRC by applying a flat rate percentage to its gross (VAT-inclusive) turnover. The flat rate percentage depends on the type of business.

As announced at the time of the 2016 Autumn Statement, from 1 April 2017 onwards, in determining which percentage to use, a business will also need to determine whether it is a ‘limited cost trader’. This is a trader whose VAT inclusive expenditure on goods is either less than 2% of their VAT inclusive turnover for the prescribed accounting period or more than 2% of VAT inclusive turnover but less than £1,000 a year. In working out if the 2% test is met, capital expenditure, expenditure on food and drink for consumption by the flat rate business or its employees and expenditure on vehicles, vehicle parts and fuel (other than where the business is one that carries out a transport service) is ignored.

Where from 1 April 2017 a business using the flat rate scheme meets the definition of a ‘limited cost trader’, that business will have to work out VAT payable to HMRC using a flat rate percentage of 16.5% rather than the lower flat rate percentage applicable to its business sector.