VAT Accounting Schemes: Cash, Flat Rate and Annual Accounting
HMRC offers three optional VAT schemes that can make VAT simpler or easier on your cash flow: the Cash Accounting Scheme, the Flat Rate Scheme and the Annual Accounting Scheme. In this plain-English guide we summarise HMRC's webinar on the schemes: what each one is, who can use it, when it may or may not suit you, worked examples, and how to join and leave. Links to the official guidance are at the end.
The 5 key points
1. All three are optional, with turnover limits
Cash accounting and annual accounting are open to VAT-registered businesses expecting VAT taxable turnover of £1.35 million or less in the next 12 months. The Flat Rate Scheme limit is £150,000, excluding VAT.
2. Cash accounting follows the money
You pay VAT when your customers pay you and reclaim it when you pay your suppliers. That helps cash flow and means no VAT on bad debts. You don't need to tell HMRC when you join or leave.
3. Flat rate changes what you pay HMRC, not what you charge
You pay HMRC a fixed percentage of your VAT-inclusive turnover, but still charge customers the normal rate of VAT. You usually can't reclaim VAT on purchases, apart from capital goods costing £2,000 or more.
4. Check whether you're a limited cost business
If you spend very little on goods, you must use the 16.5% flat rate whatever your trade. Check this with HMRC's online flat rate tool before relying on your sector's rate.
5. Annual accounting means one return, and one repayment
You send one VAT Return a year and pay in nine monthly (or three quarterly) instalments plus a balancing payment. You only get one repayment a year, so it rarely suits businesses that usually reclaim VAT.
First, how standard VAT accounting works
Without a scheme, you account for VAT on the invoices you issue and receive, whether or not they have been paid, and send a VAT Return every three months.
The VAT you charge your customers. You pay this to HMRC.
The VAT you pay on your business purchases. You reclaim this from HMRC.
Output tax minus input tax gives a VAT payment or, if your input tax is higher, a repayment. For example, if you charge £2,000 output tax and pay £3,000 input tax, HMRC pays you £1,000. Each scheme below changes when or how you work out these figures.
The Cash Accounting Scheme
Under cash accounting you pay VAT on your sales when your customers pay you, and reclaim VAT on your purchases when you pay your suppliers. "Cash" refers to timing, not how you are paid: you can still use the scheme if your customers pay by card or bank transfer.
Who can use it
- You must be registered for VAT.
- You must reasonably expect your VAT taxable turnover in the next 12 months to be £1.35 million or less.
Your customers are slow to pay, or you have bad debts. You never pay HMRC VAT you haven't received, and there is no VAT to pay on invoices that are never paid.
You regularly reclaim VAT, or you buy goods and services on credit. You can't reclaim the VAT on a purchase until you have paid the supplier.
Joining and leaving
- You don't need to tell HMRC you're joining. Make a note on your VAT records of the date you started.
- You can leave at any time, again without telling HMRC.
You must stop using the scheme if:
- you can't meet the scheme's record-keeping requirements
- at the end of a VAT accounting period, your taxable supplies for the last year are more than £1.6 million
- HMRC withdraws your use of the scheme
- you're convicted of a VAT offence, accept an offer to compound proceedings for a VAT offence, or are assessed to a penalty for VAT evasion involving dishonest conduct.
Example: Carly the photographer
Carly uses cash accounting and gives her customers 30 days to pay. The scheme helps her cash flow because she only pays the VAT once her customers have paid, and if a customer never pays, she pays no VAT on that bad debt. In return she must record every payment in and out, and keep track of who owes her money and who she owes.
The Flat Rate Scheme
Under the Flat Rate Scheme you pay HMRC a fixed percentage of your VAT-inclusive turnover, using the rate for your type of business. You still charge your customers VAT at the standard, reduced or zero rate as usual, but you generally don't reclaim VAT on your purchases.
Who can use it
- You must be a VAT-registered business.
- You must expect your VAT taxable turnover in the next 12 months to be £150,000 or less, excluding VAT.
- You must leave if your total income, including VAT, goes over £230,000 in the year to the anniversary of joining.
Two different turnover figures
Used for the £150,000 joining test. Excludes VAT. Includes standard, reduced and zero-rated supplies, but not exempt supplies.
Used to work out what you pay HMRC. Includes VAT. Includes standard, reduced and zero-rated supplies and exempt supplies.
Finding your rate
- Find your business type in HMRC's list of flat rates. For example, accountancy or book-keeping is 14.5%, advertising 11% and catering, including restaurants and takeaways, 12.5%.
- Check whether you're a limited cost business. If your VAT-inclusive spending on goods is less than 2% of your flat rate turnover, or more than 2% but less than £1,000 a year, you must use 16.5% instead.
- HMRC's online tool, Check your VAT flat rate, works this out for you.
- In your first year of VAT registration you can take 1% off your flat rate.
Example: Imogen and the Flat Rate Scheme
- Sales: £25,000, plus VAT charged at 20%: £5,000.
- VAT-inclusive (flat rate) turnover: £30,000.
- VAT paid to HMRC at her 12.5% flat rate: £3,750.
- Imogen keeps £1,250 of the £5,000 VAT she charged, but she does not reclaim VAT on her purchases.
Capital purchases
You don't usually reclaim VAT on purchases under the scheme. The exception is capital expenditure goods: you can reclaim the VAT on a single purchase of capital goods, such as a van, costing £2,000 or more including VAT. Running costs such as fuel do not count.
You want fewer records to keep and a fixed rate that is simple to apply, and you can benefit from the first-year discount.
You usually receive VAT repayments, make mainly zero-rated or exempt supplies, or buy and sell goods outside the UK.
The Annual Accounting Scheme
Normally you pay VAT, reclaim VAT and send a VAT Return every three months. Under annual accounting you send one VAT Return a year and spread your VAT bill over advance payments.
Pay VAT, reclaim VAT and send a VAT Return every three months.
Nine monthly payments (or three quarterly payments) and one VAT Return a year. Only one VAT repayment each year.
Who can use it
- You must be registered for VAT.
- You must reasonably expect your VAT taxable turnover in the next 12 months to be £1.35 million or less.
How the payments work
- Apply to join using form VAT600AA. You'll get confirmation in your VAT online account, or by post if you applied on paper.
- Make nine advance payments, then one balancing payment when you send your annual VAT Return. Pay through GOV.UK's Pay your VAT bill service.
- If you've been VAT registered for less than 12 months, your advance payments are based on an estimate for the coming year. After 12 months, they're based on your previous year's VAT.
Example: Adam's VAT bill
- Adam's VAT bill is £10,000, so each advance payment is 10%: £1,000. Nine payments total £9,000.
- His annual VAT Return shows VAT due on sales (Box 1) of £14,500, VAT reclaimed on purchases (Box 4) of £3,000 and net VAT to pay (Box 5) of £11,500.
- His balancing payment is £11,500 minus the £9,000 already paid: £2,500.
Leaving the scheme
You can leave at any time, but you must leave if you're no longer eligible. Write to HMRC at BT VAT, HM Revenue and Customs, BX9 1WR, and they'll confirm when you can leave. From that date you account for VAT in the usual way. You have to wait 12 months before you can rejoin.
Quick check: three questions from the webinar
If your customers all pay by card or bank transfer, can you still use the Cash Accounting Scheme?
Yes. The scheme is about when you account for VAT, not how you are paid. 80% of the webinar audience got this right.
You sell standard-rated goods and your flat rate is 10%. What VAT do you charge customers?
The 20% standard rate. Your flat rate only decides what you pay HMRC. 78% of the audience answered correctly.
Under the Annual Accounting Scheme, how many VAT Returns do you send each year?
One. 71% of the audience answered correctly.
Official guidance
- VAT Cash Accounting Scheme
- VAT Flat Rate Scheme
- VAT Annual Accounting Scheme
- VAT Notice 731: cash accounting
- VAT Notice 733: Flat Rate Scheme for small businesses
- VAT Notice 732: annual accounting
- VAT: detailed information
Not sure which scheme suits your business? We can compare the schemes against your own figures, set up the right scheme in Xero and keep your Making Tax Digital VAT returns on track.
Talk to us about VAT schemesThis guide summarises the slides from HMRC's recorded webinar on VAT accounting schemes, checked against HMRC's published guidance. It is general information, not advice for your specific circumstances. Rules change, so check the official guidance or speak to us before acting.