Flat Rate VAT Scheme & Corporation Tax

Flat Rate VAT Scheme & Corporation Tax

If your limited company uses the Flat Rate VAT Scheme (FRS), you're probably enjoying the simplicity — apply a single percentage to your gross turnover, pay that to HMRC, and keep the difference. But have you considered how the scheme affects your corporation tax bill?

The VAT surplus you keep under the Flat Rate Scheme is taxable profit. Many directors miss this, leading to unexpected tax bills or errors on their CT600. This guide explains exactly how the Flat Rate Scheme interacts with corporation tax, how to account for the surplus correctly, and whether the scheme is still worth using after the limited cost trader rules.

How the Flat Rate Scheme Works — A Quick Recap

Under the standard VAT scheme, you charge VAT on sales, reclaim VAT on purchases, and pay the difference to HMRC. Under the Flat Rate Scheme:

1. You charge customers the standard 20% VAT on invoices
2. You apply a flat rate percentage to your gross (VAT-inclusive) turnover
3. You pay that flat rate amount to HMRC
4. You keep the difference between the VAT you charged and the flat rate amount

The flat rate percentage depends on your industry. For example:

In the first year of VAT registration, you get a further 1% discount on your flat rate.

Example: IT consultant

You invoice £10,000 + £2,000 VAT = £12,000 gross per month.

• Flat rate payment to HMRC: £12,000 × 14.5% = £1,740
• VAT you charged: £2,000
• VAT surplus (you keep): £2,000 − £1,740 = £260 per month

Over a year, that's £3,120 of extra profit your company retains. And here's the critical point: HMRC considers that £3,120 to be taxable income for corporation tax purposes.

The VAT Surplus Is Taxable Profit

This is the most important thing to understand: the difference between the VAT you charge customers and the amount you pay to HMRC under the Flat Rate Scheme is treated as additional income of the company.

It's not a VAT refund or a tax-free benefit. It's revenue that increases your taxable profits.

How it appears in your accounts

Your accounts should show:

• Revenue (turnover): Your net sales excluding VAT — e.g., £120,000
• Flat Rate VAT surplus: £3,120 — shown as other income or included within turnover
• Corporation tax is calculated on profits including this surplus

Some accounting software handles this automatically. Others require a manual adjustment. If you're preparing accounts for your CT600, make sure the surplus is included in your profit figure.

The corporation tax impact

At the 25% main rate, a £3,120 surplus costs you £780 in additional corporation tax. At the 19% small profits rate, it costs £592.80.

So your actual benefit from the Flat Rate Scheme (after CT) is:

Still worthwhile — but less than the headline surplus suggests.

Limited Cost Traders — The Game Changer

In April 2017, HMRC introduced the limited cost trader test. If your company spends less than 2% of gross turnover on relevant goods (or less than £1,000 per year), you're classified as a limited cost trader and must use a flat rate of 16.5% regardless of your industry.

What counts as "relevant goods"?

• Physical goods used in your business
• Not included: services, capital expenditure, food/drink for personal consumption, vehicles and parts, fuel

For most service-based companies (IT consultants, management consultants, freelancers), goods spending is minimal. This means they'll almost certainly be limited cost traders.

The impact on the surplus

Using the same IT consultant example:

• Gross turnover: £12,000/month
• Limited cost trader rate: 16.5%
• Payment to HMRC: £12,000 × 16.5% = £1,980
• VAT charged: £2,000
• Monthly surplus: £2,000 − £1,980 = £20
• Annual surplus: £240

After corporation tax at 25%, you keep just £180 per year. The scheme still saves money, but barely. The main remaining benefit is simplicity — you don't need to track input VAT on individual purchases.

Should You Stay on the Flat Rate Scheme?

Whether the FRS is still worthwhile depends on your specific circumstances:

Stay on FRS if:

• You're not a limited cost trader (you buy significant goods)
• You value simplicity over marginal savings
• Your business has very few purchase invoices (less VAT to reclaim anyway)
• You're in your first year of VAT registration (extra 1% discount)

Leave FRS if:

• You're classified as a limited cost trader and the surplus is negligible
• You have significant allowable purchases with reclaimable VAT (equipment, subcontractors who charge VAT, office rent with VAT)
• You want to reclaim VAT on a large capital purchase (the FRS doesn't allow input VAT recovery except on capital goods over £2,000)
• Your effective VAT rate under the standard scheme would be lower than the flat rate

How to switch

You can leave the Flat Rate Scheme at any time by writing to HMRC or using your VAT online account. You must leave if your total income (including VAT) exceeds £230,000 in any 12-month period.

How to Report VAT on Your CT600

The CT600 itself doesn't have a specific box for VAT scheme details. Corporation tax is calculated on your accounting profit, which should already reflect the correct VAT treatment. Here's what you need to ensure:

Under the Flat Rate Scheme

1. Record turnover net of VAT as normal
2. Record the flat rate surplus as additional income (either within turnover or as "other income")
3. Do not claim input VAT on purchases (since you haven't reclaimed it from HMRC) — instead, record purchases at their gross (VAT-inclusive) amount
4. Your accounts and CT600 computations should reflect the true profit including the surplus

Under the standard VAT scheme

1. Record turnover net of VAT
2. Record expenses net of VAT (since you reclaim input VAT)
3. VAT is a balance sheet item — it flows through your VAT control account, not through profit and loss

Common accounting errors

Mistake 1: Recording revenue as VAT-inclusive under FRS without adjusting for the flat rate payment — this overstates turnover.

Mistake 2: Recording expenses net of VAT under FRS — you shouldn't strip VAT from expenses if you're not reclaiming it.

Mistake 3: Forgetting to include the flat rate surplus in corporation tax computations — this understates taxable profit.

Switching Schemes Mid-Year

If you switch from the Flat Rate Scheme to the standard scheme (or vice versa) during an accounting period, your accounts need to handle both periods correctly:

• FRS period: Gross expenses, surplus as income
• Standard period: Net expenses, input VAT reclaimed
• Transition: You may need to account for VAT on stock and assets at the changeover date

This can get complex. If you're filing your CT600 yourself, make sure your accounting software handles the transition properly, or seek professional advice for the changeover period.

The Flat Rate Scheme and Capital Allowances

Under the Flat Rate Scheme, you generally can't reclaim input VAT on purchases. This means you claim capital allowances on the gross (VAT-inclusive) cost of assets.

Example: Buying a laptop for £1,200 including VAT

• Under FRS: Claim capital allowances on £1,200. No VAT recovery.
• Under standard scheme: Reclaim £200 VAT, claim capital allowances on £1,000.

For smaller items covered by the Annual Investment Allowance, the FRS actually gives you a higher capital allowance deduction — though you've also paid more for the asset.

The net effect depends on your CT rate:

In this case, the standard scheme saves £350 more. For capital-intensive purchases, leaving the FRS can be significantly better.

Exception: Capital goods over £2,000

Under the Flat Rate Scheme, you can reclaim VAT on individual capital goods costing £2,000 or more (including VAT). So if you buy equipment for £2,400 including VAT, you can reclaim the £400 VAT even while on the FRS. This is a frequently overlooked benefit.

Worked Example: Full-Year Comparison

Company: A management consultancy with annual turnover of £100,000 (net of VAT). No significant goods purchases. One director, no employees.

Under the Flat Rate Scheme (limited cost trader)

Under the standard VAT scheme

In this example, the FRS produces a lower taxable profit (£84,600 vs £87,000) because the gross expenses under FRS are higher than the net expenses under the standard scheme. The FRS saves approximately £638 in corporation tax — but the actual cash difference is much smaller once you account for the VAT flows.

The point: always compare both schemes based on your specific numbers, not just the headline surplus.

How Taxpipe Handles VAT and Corporation Tax

When you use Taxpipe to file your CT600, you enter your profit figures from your annual accounts — which should already reflect the correct VAT treatment under whichever scheme you use. Taxpipe then calculates your corporation tax, applies marginal relief where applicable, and generates the iXBRL-tagged accounts for submission.

Not sure if your numbers are right? Check our complete guide to allowable expenses or try our corporation tax calculator to model different scenarios.

Ready to file? See our pricing plans — filing starts from just £69 + VAT.

FAQ

Is the Flat Rate VAT surplus taxable for corporation tax?

Yes. The difference between the VAT you charge customers and the amount you pay HMRC under the Flat Rate Scheme is treated as taxable income. It must be included in your corporation tax computation and reported on your CT600.

What is the flat rate for a limited cost trader?

16.5% of gross (VAT-inclusive) turnover. You're a limited cost trader if you spend less than 2% of gross turnover on relevant goods, or less than £1,000 per year. Most service businesses fall into this category.

Can I reclaim VAT on purchases under the Flat Rate Scheme?

Generally no — that's the trade-off for the simplified calculation. However, you can reclaim VAT on individual capital goods costing £2,000 or more (including VAT). You also claim capital allowances on the gross cost of assets since you haven't recovered the VAT.

How do I account for expenses under the Flat Rate Scheme?

Record expenses at their gross (VAT-inclusive) amount, since you're not reclaiming input VAT. This means your expense figures will be higher than under the standard scheme, but you don't have a VAT refund to offset against it.

Should I leave the Flat Rate Scheme?

It depends on your costs. If you're a limited cost trader with few purchases, the surplus is minimal and the main benefit is simplicity. If you have significant VAT-able expenses (equipment, software, subcontractors), the standard scheme may save you more overall. Compare both using your actual figures.

Does the Flat Rate Scheme affect my corporation tax rate?

Indirectly, yes. The VAT surplus increases your taxable profit, which could push you into a higher corporation tax band. For FY 2024-25 onwards, profits under £50,000 pay 19%, profits over £250,000 pay 25%, and profits between £50,000 and £250,000 are subject to marginal relief at an effective rate of up to 26.5%.

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