If you are VAT-registered, the standard way of working out your VAT is not your only choice. HMRC offers several special schemes that can make VAT simpler, smooth out your cash flow or reflect how your business actually trades. Picking the right one can save you time, stress and sometimes money. Picking the wrong one can quietly cost you.
In this guide we explain the five main VAT schemes in plain English: what each one does, who it tends to suit and what to watch out for. We have kept figures general on purpose, because HMRC reviews limits and rates from time to time. Always check the current numbers on GOV.UK or with your accountant before you decide.
First, a quick reminder of how standard VAT works
Under standard VAT accounting, you add VAT to the sales you make (your output tax) and you reclaim the VAT you pay on business costs (your input tax). On each VAT return you pay HMRC the difference, or claim a refund if you paid out more than you charged.
Standard accounting also works on invoice dates. So you owe VAT on a sale when you issue the invoice, even if your customer has not paid you yet. Most businesses file returns every quarter.
Each special scheme changes one part of this picture. Some change how much VAT you work out, some change when you pay it, and some change how often you file.
Heads up - whichever scheme you use, Making Tax Digital (MTD) for VAT still applies. MTD is HMRC's rule that VAT-registered businesses keep their records digitally and send returns using compatible software. The schemes change your calculations, not the need for digital records.
The Flat Rate Scheme
What it does
With the Flat Rate Scheme, you still charge your customers VAT at the normal rate. But instead of working out the difference between the VAT you charge and the VAT you pay, you pay HMRC a fixed percentage of your VAT-inclusive turnover. The percentage depends on your type of business, and HMRC publishes a list of sector rates.
In return, you usually cannot reclaim VAT on your purchases. The main exception is certain larger purchases of capital goods, such as equipment, above a value set by HMRC.
Who it suits
- Small businesses with a turnover below HMRC's joining limit.
- Service businesses with few VAT-able costs, such as consultants, designers and some trades.
- People who want simpler bookkeeping and fewer calculations on each return.
What to watch out for
- The limited cost trader rule. If you spend very little on goods, HMRC treats you as a limited cost trader and you must use a higher flat rate. For many service businesses, this removes most or all of the benefit. You need to check this test every return period.
- You lose input tax. If you buy a lot of VAT-able goods or supplies, you may pay more under Flat Rate than under standard accounting.
- You must leave if you grow. There is a turnover limit for staying in the scheme, and you have to leave if you go over it.
- A first-year discount. Newly VAT-registered businesses can usually take a small reduction on their flat rate for their first year. Check the current details.
The Flat Rate Scheme is about simplicity. It only saves money if your costs are low but not so low that you count as a limited cost trader.
The Cash Accounting Scheme
What it does
Cash Accounting changes when you account for VAT. Instead of using invoice dates, you pay VAT on sales when your customers actually pay you. And you reclaim VAT on purchases when you actually pay your suppliers.
Who it suits
- Businesses whose customers often pay late or on long credit terms.
- Anyone worried about paying HMRC VAT on money they have not yet received.
- Small businesses below HMRC's turnover limit for joining the scheme.
What to watch out for
- Slower reclaims. You cannot reclaim VAT on a purchase until you have paid for it. If you buy on credit, this can work against you.
- Built-in bad debt protection. If a customer never pays, you never pay the VAT on that sale. This is one of the scheme's biggest benefits.
- Some things are excluded. For example, you generally cannot use Cash Accounting for goods bought or sold on hire purchase, lease purchase or similar credit deals. You also cannot join if you are behind with VAT returns or payments.
- Leaving the scheme. If your turnover rises above HMRC's exit limit, you must leave. When you leave, you will need to account for any VAT still outstanding on unpaid invoices.
- Not with Flat Rate. You cannot use the Cash Accounting Scheme alongside the Flat Rate Scheme. But Flat Rate has its own option to work out turnover on a cash basis, which gives a similar result.
The Annual Accounting Scheme
What it does
With Annual Accounting, you file one VAT return a year instead of four. During the year you make advance payments towards your VAT bill, either monthly or quarterly. These are based on your previous VAT, or an estimate if you are new. At the end of the year you file your return and either pay a balancing amount or get a refund.
Who it suits
- Small businesses under HMRC's turnover limit for joining.
- People who like to budget with regular, predictable payments.
- Owners who find quarterly returns a burden on their time.
What to watch out for
- Refunds take longer. If you usually get money back from HMRC, you will only get it once a year. That is usually a poor fit for businesses that regularly reclaim VAT.
- Payments may not match reality. If your turnover drops, your advance payments may be too high until you ask HMRC to change them. If it rises, you could face a larger bill at year end.
- Record keeping still matters. One return a year does not mean doing your books once a year. Under MTD you still keep digital records as you go.
- It combines well. You can usually use Annual Accounting together with Cash Accounting or the Flat Rate Scheme.
The Margin Schemes
What they do
Margin schemes are for businesses that buy and resell second-hand goods, works of art, antiques and collectors' items. Instead of charging VAT on the full selling price, you pay VAT only on your margin: the difference between what you paid for an item and what you sold it for.
This matters because you often buy these goods from private individuals who do not charge VAT. Without a margin scheme, you would pay VAT on the full sale price with nothing to reclaim.
Who they suit
- Second-hand car dealers.
- Antique, vintage and second-hand furniture sellers.
- Art dealers and galleries.
- Resellers of used goods, such as clothing, electronics or collectables.
What to watch out for
- Strict records. You need to keep detailed stock records for each item, including purchase and sale details. Missing records can mean HMRC charges VAT on the full price.
- Special invoicing. You must not show VAT separately on a margin scheme invoice. Your customer cannot reclaim it.
- Losses do not help. If you sell an item for less than you paid, there is no VAT to pay on it, but you cannot use that loss to reduce VAT on other sales under the standard item-by-item method.
- You choose per item. You can use the margin scheme for eligible items and normal VAT for others, as long as your records keep them clearly apart.
- Different versions exist. There are variations, such as a global accounting method for lower-value, bulk items. Check which one fits your stock.
The Retail Schemes
What they do
Retail schemes help shops and other retailers who sell to the public and cannot easily record the VAT on every single sale. This is especially useful if you sell a mix of standard-rated, reduced-rated and zero-rated goods. Instead of tracking each item, the scheme gives you a fair way to split your takings between the different VAT rates.
There are three standard retail schemes:
- Point of Sale - you record the VAT rate of each sale at the till. This suits businesses with modern till systems.
- Apportionment - you split your takings based on the proportion of goods you bought for resale at each VAT rate.
- Direct Calculation - you work out the expected selling prices of goods at one rate, then treat the rest of your takings as the other rate.
Very large retailers above a certain turnover must agree a bespoke retail scheme with HMRC instead.
Who they suit
- Shops, newsagents, grocers, chemists and cafés that also sell goods.
- Businesses selling mostly to the public rather than to other VAT-registered businesses.
What to watch out for
- You must still issue a VAT invoice if a VAT-registered customer asks for one.
- Some schemes have their own turnover limits, so check which you can use.
- Your chosen scheme must give a fair result. HMRC can challenge a method that does not reflect what you actually sell.
Which VAT scheme suits whom? A side-by-side view
| Scheme | What it changes | Often suits | Main thing to check |
|---|---|---|---|
| Flat Rate | How much VAT you pay | Small service businesses with low costs | Limited cost trader rule and lost input tax |
| Cash Accounting | When you pay and reclaim VAT | Businesses with slow-paying customers | Turnover limits and slower reclaims |
| Annual Accounting | How often you file | Small businesses wanting predictable payments | Refunds only once a year |
| Margin | What you charge VAT on | Sellers of second-hand goods, art and antiques | Detailed stock records for every item |
| Retail | How you split takings between VAT rates | Shops selling mixed-rate goods to the public | Choosing a method that gives a fair result |
Can you combine VAT schemes?
Some schemes work well together and some do not. As a general guide:
- Annual Accounting can usually be combined with Cash Accounting or the Flat Rate Scheme.
- Cash Accounting and Flat Rate cannot be used together, although Flat Rate has its own cash-based option.
- Flat Rate generally does not sit alongside the margin or retail schemes, because it replaces the normal calculation altogether.
The rules on combining schemes have some detail and exceptions, so check HMRC's guidance for each scheme or ask your accountant before you mix them.
A note for landlords
If you let residential property, your rent is usually exempt from VAT. That means you normally cannot register for VAT on that income, and these schemes will not apply to you.
It is different if you let commercial property and have chosen to charge VAT on the rent (known as an option to tax). In that case you may be VAT-registered, and schemes such as Cash Accounting or Annual Accounting could be worth considering. Commercial property VAT can be complex, so we recommend taking advice.
How to choose, and how to join or leave
Before you decide, it helps to run through a few simple questions:
- Do my customers pay late? If so, Cash Accounting may ease your cash flow.
- Do I spend much on VAT-able costs? If not, Flat Rate might simplify things, but check the limited cost trader rule first.
- Do I usually get VAT refunds? If so, avoid Annual Accounting and possibly Flat Rate.
- Do I sell second-hand goods, art or antiques? Look at the margin schemes.
- Do I run a shop selling mixed-rate goods? Look at the retail schemes.
A useful exercise is to take your last year's figures and work out what you would have paid under standard accounting and under the scheme you are considering. The numbers often make the decision for you.
You can usually apply for most schemes when you register for VAT or later, and some you simply start using if you meet the conditions. Each scheme has its own rules on joining, leaving and how soon you can rejoin. Keep an eye on your turnover, because growing past a scheme's limit usually means you must leave it.
Heads up - a scheme that suited you when you started may not suit you now. It is worth reviewing your VAT scheme each year, or whenever your business changes shape.
In summary
VAT schemes exist to make life easier for smaller and specialist businesses. The Flat Rate Scheme simplifies your calculations. Cash Accounting protects your cash flow. Annual Accounting cuts down your paperwork. And the margin and retail schemes make VAT fairer for businesses whose sales do not fit the standard mould.
There is no single right answer. The best scheme is the one that fits how you actually trade, and it is fine to change as your business grows. If you are unsure, compare the numbers, read HMRC's guidance for each scheme and talk to your accountant. Whatever you choose, TaxOptimiser can help you keep digital records and file your VAT returns under Making Tax Digital with confidence.