VAT Flat Rate Scheme: a 2025-26 explainer

VAT can seem daunting, but as 2025-26 dawns, have you considered making life easier by using the Flat Rate Scheme?

Flat Rate Scheme questions to ask yourself as a contractor

In fact, while VAT can be complex, what if there was a way to make Value Added Tax easier for you and your limited company?

And what if that way could also save time so you could use your skills to boost your business and not be overwhelmed with paperwork and administration?

The Flat Rate Scheme available from HMRC may be an option for you to consider if all that sounds appealing. With the 2025-2026 new tax year less than a week away, one advantage of last week’s uneventful Spring Statement 2025, is that the ‘nuts and bolts’ of the FRS are the same, writes Lisa Somerton, a manager at Jenner & Co. 

First consideration: VAT registration threshold

A business (whether a limited company, a partnership or a sole trader) must register for VAT if their income in a 12-month rolling period exceeds £90,000. 

Under the ‘traditional’ VAT scheme, you charge and pay VAT on your sales and reclaim VAT on your eligible purchases.

How does the Flat Rate Scheme differ from this ‘traditional’ VAT scheme? 

Well, with the Flat Rate Scheme, a business pays a fixed rate of VAT to HMRC depending on its sector of trade. 

You would not reclaim the VAT on any purchases other than capital assets worth over £2,000. 

The VAT that is paid over to HMRC is calculated on the gross sales that are received.

The flat rate percentage that you pay depends on whether you are a “limited cost” trader or not. 

What is a ‘limited cost’ trader, and are you one?

As HMRC explains here, a ‘limited cost’ trader is a business that incurs ‘costs for goods’ (not overheads) of either less than 2% of turnover or £1,000 per annum. 

If that is the case, the flat rate to be used is 16.5%. 

If you are not a limited cost trader, then you will have a set percentage that is relevant to your sector of trade.

What about IT contractors and FRS or limited costs?

According to HMRC’s ‘a-z’ of flat rate percentages by trade, an IT consultant (who is not a limited cost trader) would fall into the category “Computer and IT consultancy or data processing.” Such a tech contractor would have a VAT flat rate of 14.5%.

But how does the VAT FRS work, in practice?

Jan, a limited company IT contractor invoices their client £1,000 plus VAT and receives the full £1,200. 

Jan is not a limited cost trader as their goods purchases in the quarter cost more than 2% of turnover.  Jan can apply the 14.5% rate, and will pay HMRC £1,200 x 14.5% = £174. 

Jan has collected £200 from their client so the difference of £26 remains in the business as a profit.

Keep costs under review (especially if you’re a tech consultant like Jan)

Each quarter Jan would have to review costs and ensure that the 2% of turnover rule is still being met, or that the £1,000 per annum isn’t being exceeded, remains the same, in order to keep using the lower rate of 14.5%.

If in any quarter Jan does not meet the requirements, Jan would have to use the blanket rate of 16.5% for limited cost traders.

In the example above, Jan would pay £198 to HMRC, leaving a flat rate scheme profit in the business of only £2.

With limited costs under FRS, what costs are excluded?

Be mindful that there are many expenses among the costs that are excluded, when calculating the ‘costs of goods’ for the limited cost trader requirement.  

Mainly those excluded items are:

• wages;
• travel, accommodation, food and drink;
• vehicle costs;
• rent;
• internet/phone bills;
• accountancy fees;
• goods for resale or hire;
• training;
• office equipment, computer equipment, mobile phones;
• gifts and donations.

How FRS helps cash flow

Appealingly, the Flat Rate Scheme works on a ‘cash-based’ method rather than an accrual basis, so it can help with cash flow as you are only paying HMRC on the sales that you have actually received in the quarter.

In other words, as an FRS scheme user, you don’t pay HMRC for sales invoices that are yet to be paid.

FRS: What turnover requirements to be eligible?

Unchanged by Wednesday’s Spring Statement 2025, the FRS is open to businesses with a turnover of less than £150,000 in any 12-month rolling period.

And you can remain in the scheme as long as your turnover is not expected to exceed £230,000 in the next 12 months or the next 30 days alone. 

Leaving and joining the HMRC scheme

You can leave the Flat Rate Scheme at any time.

At the other end of the spectrum, there are certain factors which may exclude you from being in the Flat Rate Scheme in the first place, such as exiting it in the last 12 months.

An application to join the FRS can be made to HMRC either online or by post and once approved, HMRC will confirm if you are eligible to use the scheme. 

What is the FRS first-year discount?

Positively, in the first year of being in the Flat Rate Scheme, there is a 1% discount on the percentage you apply for. Potentially, this discount can make all the difference.

For our IT consultant Jan, this ‘first-year discount’ means that they would be able to use a rate of 13.5%, rather than 14.5% (albeit just in the first year of being registered under the Flat Rate Scheme).

Is Flat Rate VAT for you in 2025-26?

As you can hopefully see, HMRC’s Flat Rate Scheme can be really useful to those smaller businesses who do not incur a lot of VAT on their purchases; wish to ease their administrative burden, and have simpler records and reporting obligations while boosting their cash flow. Talk through the scheme with a trusted accountant if it sounds of interest to you and your limited company.