VAT schemes in the UK: standard, flat rate, cash and annual accounting.

Start with standard VAT accounting

Every scheme is a change to the default, so it helps to know the default first. You must register for VAT once your taxable turnover for the last 12 months goes over £90,000. After that, standard VAT accounting works like this:

• You charge VAT on your sales and record it from your sales invoices
• You reclaim VAT on your purchases from your purchase invoices
• You file a return every 3 months. The return and payment are normally due one calendar month and 7 days after the end of the period.

You pay HMRC the difference between the VAT you charged and the VAT you paid. If you paid more than you charged, HMRC repays you.

You reclaim the actual VAT on your costs. The catch is that you report and pay VAT even if the invoices have not been paid yet.

The Flat Rate Scheme

The Flat Rate Scheme is designed to make VAT simpler for small businesses. You can join if you expect your VAT taxable turnover in the next 12 months to be £150,000 or less, excluding VAT.

How it works

You still charge your customers VAT at the normal rate. But instead of working out the VAT you charged minus the VAT you paid, you pay HMRC a fixed percentage of your VAT-inclusive turnover. You keep the difference.

The percentage usually depends on your type of business. HMRC publishes a table of flat rates for different business types. New businesses get a 1% discount on their rate during their first year of VAT registration.

In return for the simpler sums, you give up most input VAT. You cannot reclaim VAT on your purchases, except on a single purchase of capital goods costing £2,000 or more, including VAT.

The limited cost business rate

Some businesses spend very little on goods. HMRC classes you as a "limited cost business" if your spending on goods, including VAT, is less than 2% of your turnover, or more than 2% but less than £1,000 a year. If that applies, you pay a flat rate of 16.5% instead of the rate for your business type.

This catches many service businesses, such as consultants and freelancers, whose main costs are services rather than goods. At 16.5% of a VAT-inclusive figure, the scheme can end up costing more than standard accounting.

Who cannot use it

You cannot join the Flat Rate Scheme if any of these apply:

• You left the scheme in the last 12 months
• You committed a VAT offence, such as VAT evasion, in the last 12 months
• You joined, or were eligible to join, a VAT group in the last 24 months
• You registered for VAT as a business division in the last 24 months
• Your business is closely associated with another business
• You use a margin scheme or the capital goods scheme

You also cannot use it at the same time as the Cash Accounting Scheme.

When you have to leave

You check your turnover each year on the anniversary of joining. You must leave if your total income, including VAT, for the year just ended is more than £230,000. HMRC may let you stay if it is satisfied your income in the next 12 months will not go over £191,500. You must also leave if you expect income of more than £230,000 in the next 30 days alone. Once you leave, you must wait 12 months before rejoining.

The Cash Accounting Scheme

Cash accounting changes when VAT is counted, not how much. You can join if you estimate your VAT taxable turnover in the next 12 months will be £1.35 million or less.

Under this scheme:

• You pay VAT on a sale when your customer pays you, not when you send the invoice
• You reclaim VAT on a purchase when you pay your supplier, not when you receive the invoice

The main benefit is cash flow. If customers take 60 or 90 days to pay, you are not paying VAT to HMRC on money you have not received. If a customer never pays, you never pay the VAT on that sale.

The trade-off is that you wait longer to reclaim VAT on your own costs, because the claim only comes once you have paid.

Exclusions and leaving

You cannot use cash accounting if you are on the Flat Rate Scheme, if you are not up to date with your VAT returns or payments, or if you committed a VAT offence in the last 12 months.

Some transactions stay on standard accounting even inside the scheme. These include invoices with payment terms of 6 months or more, invoices raised in advance, and goods bought or sold under lease purchase, hire purchase, conditional sale or credit sale.

You must leave the scheme if your VAT taxable turnover goes over £1.6 million.

The Annual Accounting Scheme

Annual accounting changes how often you file. Instead of four returns a year, you send one. You can join if your estimated VAT taxable turnover for the next 12 months is £1.35 million or less.

How the payments work

You make advance payments through the year, based on your last return or an estimate if you are new to VAT. You choose either:

• Monthly payments of 10% of your estimated VAT bill, due at the end of months 4 to 12
• Quarterly payments of 25%, due at the end of months 4, 7 and 10

For a 12-month period, the return is due 2 months after the end of the year, along with a balancing payment for any shortfall. If you have paid too much, you claim a refund. All payments must be made electronically, for example by Direct Debit or internet banking.

Who it suits

It can suit a business with steady income that wants fewer deadlines and predictable payments. It does not suit a business that regularly reclaims VAT, because you only get one refund a year, when you send the return.

Who cannot use it and when you leave

You cannot use annual accounting if you left the scheme in the last 12 months, your business is part of a VAT-registered division or group of companies, you are not up to date with your VAT returns or payments, or you are insolvent. You must leave if your VAT taxable turnover is, or is likely to be, more than £1.6 million at the end of the annual accounting year.

The Annual Accounting Scheme can be used together with the Flat Rate Scheme. In that case you work out your flat rate figures once a year instead of four times, and you must pay electronically.

Other VAT schemes to know about

Margin schemes

Margin schemes are for businesses selling second-hand goods, works of art, antiques and collectors' items. You pay VAT on the difference between what you paid for an item and what you sold it for, rather than on the full selling price. The VAT is one-sixth of that margin.

You cannot use a margin scheme for items you bought with VAT charged, or for precious metals, investment gold or precious stones.

Retail schemes

Retail schemes help shops that make many small sales to the public. Instead of working out VAT on each sale, you work it out once for each return. There are three standard schemes: Point of Sale, Apportionment and Direct Calculation. If your turnover excluding VAT is over £130 million, you must agree a bespoke retail scheme with HMRC instead.

How to choose between them

There is no single best scheme. A few questions usually point the way:

• Do customers pay you late? Cash accounting stops you paying VAT before the money arrives.
• Do you buy much with VAT on it? If yes, standard or cash accounting lets you reclaim it. The Flat Rate Scheme mostly does not.
• Are you a service business with few goods costs? Check the limited cost business test before joining the Flat Rate Scheme.
• Do you often get VAT repayments? Annual accounting delays those to once a year.
• Do you want fewer deadlines? Annual accounting cuts four returns to one.

Run the numbers on a past year using your actual sales and costs. Your bookkeeping records hold everything you need for that comparison, as long as they are complete.

Why clean books matter whatever the scheme

Every scheme depends on accurate records. Cash accounting needs the exact date each customer paid and each supplier was paid. The Flat Rate Scheme needs your VAT-inclusive turnover and a clear view of what you spent on goods. Annual accounting needs records that are right all year, not rebuilt at the end.

Daily bookkeeping keeps those records ready. Bank lines are reconciled as they come in, receipts are matched to payments, and missing invoices are chased while they are still easy to find.