Flat Rate VAT vs Standard VAT

How standard VAT works

Under standard VAT accounting, you operate as a VAT collector for HMRC:

• You charge your clients VAT at the standard rate (currently 20%) on top of your fee
• You reclaim VAT on any eligible business purchases (software, equipment, office costs)
• Each quarter, you calculate the difference: VAT charged minus VAT reclaimed
• You pay that net figure to HMRC

Example: you invoice £10,000 net and charge £2,000 VAT. You spent £500 net on business purchases and paid £100 VAT on those. Your quarterly VAT bill is £2,000 minus £100 = £1,900.

Standard VAT is straightforward and benefits businesses that have significant VATable expenses, because those reclaims reduce what they owe HMRC.

How the flat rate scheme works

Under the flat rate scheme, you still charge your clients 20% VAT as normal. But instead of tracking and reclaiming VAT on every purchase, you simply pay a fixed percentage of your gross (VAT-inclusive) turnover to HMRC and keep the rest.

The fixed percentage varies by sector. The idea is that the rate is lower than 20%, so you keep a small profit — the difference between the 20% you charge clients and the lower rate you pay HMRC.

Example at a 12% flat rate: gross invoice (inc. VAT) = £12,000. Flat rate payment = £12,000 × 12% = £1,440. You charged the client £2,000 in VAT and pay only £1,440 to HMRC, keeping £560.

The catch: you cannot reclaim VAT on purchases under the flat rate scheme, except for certain capital goods over £2,000.

The limited cost trader rule

In 2017, HMRC introduced the limited cost trader rule, which significantly reduced the benefit of the flat rate scheme for most service businesses.

You are classified as a limited cost trader if your VAT-inclusive spending on goods (physical products — not services, not software, not fuel) is:

• Less than 2% of your gross (VAT-inclusive) turnover, or
• Less than £1,000 per year (even if that is more than 2%)

Limited cost traders must use a flat rate of 16.5%, rather than the lower sector rate. At 16.5%, the scheme offers almost no financial benefit over standard VAT for most freelancers.

Most freelancers — developers, designers, consultants, writers, marketers — spend little or nothing on goods and fall into the limited cost trader category. If you buy most of your business supplies as services (cloud software, accountancy, professional subscriptions) rather than goods, you are almost certainly a limited cost trader.

Flat rate percentages by sector

If you do qualify for a sector rate lower than 16.5%, here are the rates relevant to common freelance categories:

Check HMRC's full list of flat rate percentages if your category is not shown above.

Which scheme saves more: worked example

Assume a freelance developer with £100,000 gross annual turnover (£83,333 net + £16,667 VAT), spending £1,200 per year on VATable goods and £6,000 on VATable services (software, cloud tools):

Standard VAT

• VAT charged to clients: £16,667
• VAT reclaimed on goods: £200 (20% of £1,000 net)
• VAT reclaimed on services: £1,000 (20% of £5,000 net)
• Net VAT bill: £15,467

Flat rate (limited cost trader at 16.5%)

• Gross turnover: £100,000
• Flat rate payment: £100,000 × 16.5% = £16,500
• No reclaims on purchases

In this example, standard VAT costs £1,033 less per year. This is typical for most freelancers: the flat rate scheme at 16.5% costs more than standard VAT once you account for the service and software reclaims you lose.

How to choose the right scheme

Use the flat rate scheme if:

• You qualify for a sector rate significantly below 16.5%
• You have minimal VATable purchases (so reclaims would be negligible anyway)
• You value simplicity over the small financial difference

Use standard VAT if:

• You are classified as a limited cost trader (rate = 16.5%)
• You have meaningful VATable expenses you can reclaim
• You want to reclaim VAT on capital equipment purchases

When in doubt, run the numbers with your own figures or ask an accountant to calculate both scenarios. The difference is usually modest, but it is worth checking once when you register.

How to join or switch schemes

You can apply to join the flat rate scheme when you first register for VAT, or at any point afterwards by applying through your HMRC online account. HMRC will confirm your acceptance in writing.

You can leave the flat rate scheme at any time by writing to HMRC (include your VAT number and the date you want to leave). You cannot rejoin within 12 months of leaving voluntarily. HMRC can also remove you from the scheme if your total VAT-inclusive turnover exceeds £230,000.

If you are unsure which scheme to choose at registration, standard VAT is the safe default for most freelancers. It is easier to switch to flat rate later than to overpay on the flat rate and discover the error only at year end.