Understanding the VAT Flat Rate Scheme (FRS)
The FRS simplifies VAT for small businesses: instead of calculating input tax and output tax, you pay a fixed percentage based on your business type — and you normally cannot reclaim VAT on purchases. GOV.UK+1
For many service-based micro/SMEs, the simplicity seems appealing. But under recent rules, businesses spending very little on goods can be classified as “Limited Cost Traders.”
Why the Limited Cost Business classification can be costly
If more than 98% of your VAT-inclusive turnover comes from services — with little or no spend on goods — you lose the benefit of a low flat rate. Instead, HMRC imposes the punitive 16.5% flat rate. In practice, this often means you hand almost all VAT charged to you over to HMRC, drastically reducing what you keep.
Many businesses fall into this trap because they forget to count capital asset purchases or don’t track what counts as “goods.”
How bookkeeping helps you avoid the trap
Regular, clear bookkeeping highlights all your purchases — and whether they fall under “goods” or “services.” With accurate tracking and expenditure classification, you can:
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Determine whether the Flat Rate Scheme actually benefits you
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Switch to standard VAT accounting if more favourable
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Assess periodically (every quarter) whether the Limited Cost classification still applies
The bottom line — know your numbers before you decide VAT strategy
The VAT Flat Rate Scheme isn’t a one-size-fits-all solution. For many service businesses, standard VAT accounting may be more cost-effective — especially when goods, capital assets or equipment purchases amount to a modest but regular spend.
We offer bookkeeping packages from £129 per month with two months free on annual subscriptions, including bank reconciliation, VAT, PAYE and monthly reports for complete financial clarity. Need help? Email support@bookkeepingpackages.co.uk or visit our site at www.bookkeepingpackages.co.uk.
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