Indirect Tax – annual accounting and flat rate schemes part 2

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Indirect Tax series 

In part one of this article on VAT schemes we illustrated the changing role of accountants from being predominantly reactive and compliance based, to proactively adding value to clients by offering business advice.

Often when VAT schemes are discussed we launch into the details of the special ones and omit an initial explanation of the standard scheme. However, our accounting technician gave a brief overview of the standard scheme so the client will be able to make an informed decision about the special schemes in relation to the standard one.

Here is the end of the role play which explains both the annual accounting and flat rate schemes:

Accountant: Before we carry on are there any questions you want to ask me about the standard or cash accounting schemes?

Client: I think I’m okay so far and happy that cash accounting would be better for me so that I’m not paying VAT to HMRC before I even get it.

Accountant: Yes absolutely. Let me tell you about the annual accounting scheme next as you can use it alongside cash accounting. It has the advantage that you make regular set payments which helps when planning cash flow.

Client: Sounds good, but how are the payments worked out as I’m not registered at the moment?

Accountant: You can join the scheme when you register and the payments are calculated on an estimated annual VAT liability for the first year. After that it would be based on the previous year’s payment. Either, 90% of the liability would be split into nine equal monthly instalments or you’d make three interim payments of 25%. In both cases there would be a balancing payment or refund two months after the end of the VAT year.

Client: What only one?

Accountant: Yes. A great benefit of the annual scheme is that it’s only one return rather than the standard four. All schemes these days require electronic submissions and the new Making Tax Digital requirements will also apply but we can talk about that another day.

Client: It all sounds great. What’s the catch?

Accountant: Like I said with cash accounting, as you make standard rated supplies you’re not going to be regularly reclaiming VAT so the main disadvantage with the annual scheme, which is only getting any refund due at the end of the year as a single receipt, isn’t applicable. However, you should be aware, that once your payments are set they can’t be changed until the end of the VAT year.

Client: Okay. You said there are three special schemes, what’s the last one?

Accountant: It’s the flat rate schemes and it’s completely different to any of the others. You don’t owe HMRC the actually amount of VAT collected on your sales and you don’t off set the actually amount of VAT you’ve paid on purchases. Instead a set percentage is applied to your VAT inclusive sales figure to calculate the VAT owed.

Client: Hmm that sounds complicated.

Accountant: I know it sounds complicated but in reality it’s quite simple. I’ve looked up the percentage that would apply to your business and it’s 15%. Last month your sales turnover was £10,864 so if you were registered it would have been £13,036 once the VAT was added. The VAT due on that would be £1,955 as it is 15% of the VAT inclusive turnover.

Client: Right but what about the VAT I pay on purchases?

Accountant: That’s not off set as it is in the other schemes so doesn’t come into the calculation. The typical level of VAT on purchases is estimate for different industries and taken into consideration when the percentage is set for each business type.

Client: So would I add 15% to my sales invoices?

Accountant: No, that’s the flat rate that we’d use to calculate the VAT due to HMRC. You’d have to add 20% to your sales and issue VAT invoices as with all the schemes. The difference is that you won’t need to record VAT on every single transaction, however, you do still need VAT records.

Client: So, if I sell something for £100 plus VAT, I send a VAT invoice for £120 but only pay £18 to HMRC, keeping £102. But I cannot claim back any VAT paid for my purchases?

Accountant: That’s right, You pay less VAT to HMRC than you charge, but the difference compensates you for not reclaiming VAT on your purchases. That’s why different types of organisations have different flat rate percentages. Are you planning any capital purchases?

Client: Not at the moment. Why?

Accountant: You can reclaim the VAT when you purchase new assets but it needs to be both recorded and included on the VAT return separately. When you sell them in the future you’ll charge VAT and owe it to HMRC at that point.

Client: There’s a lot to take in. I’m going to need some time to think all this through.

Accountant: Of course, let me just finish by saying, you get a 1% discount off the flat rate in the first year of registration and in my experience, clients who use this scheme find it easier than the others as they don’t have to work out what VAT is reclaimable on purchases as what isn’t. With regard to disadvantages, again if you made zero rated supplies or were likely to receive regular refunds it wouldn’t be appropriate but that isn’t the case.

Client: Great. Where do we go from here then?

Accountant: Well I would definitely recommend registering for at least one of the special schemes. You can combine the annual scheme with either cash accounting or flat rate but not both. Cash accounting and the flat rate scheme can’t be used together. If you let me know your thoughts I can compile some figures that would give an indication of what your liability would be.

In an advisory role you are likely to refer the client to further information. However, if you are currently studying for an assessment, my advice is to double check the facts about the standard and cash accounting schemes.


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Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.

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