The VAT flat rate scheme, cash accounting and annual accounting: which is right for you?
The VAT flat rate scheme usually suits you if your VAT taxable turnover is £150,000 or less, you buy a fair amount of goods and your trade’s flat rate is well below the 20% you charge. It rarely suits businesses caught by the 16.5% limited cost rate. Cash accounting helps if customers pay you late, and annual accounting helps if you want 1 VAT return a year instead of 4.
Picking the wrong scheme will not break any rules, but it can cost you real money or leave you short of cash at the wrong moment. This guide compares all 3, shows the maths with worked examples and explains when to leave a scheme.
Which VAT scheme suits your business?
It depends on your costs, how quickly customers pay and how steady your VAT bills are. Flat rate suits low turnover businesses with moderate goods spending. Cash accounting suits businesses that wait to be paid. Annual accounting suits steady VAT bills and fewer returns. You can usually combine flat rate with annual accounting, but not flat rate with cash accounting.
VAT registration and scheme thresholds
Businesses must register for VAT once taxable turnover passes £90,000. You can register voluntarily below that. Our note on crossing the VAT threshold covers what happens at that point.
| Threshold | What it applies to |
|---|---|
| £90,000 of taxable turnover | VAT registration threshold |
| £150,000 or less, excluding VAT, expected in the next 12 months | Joining the flat rate scheme |
| More than £230,000 including VAT | Leaving the flat rate scheme |
| More than £1.6 million | Leaving cash accounting |
The thresholds above come from the official scheme guidance and the standard 2026/27 tables. You can read the rules for yourself on the GOV.UK flat rate scheme page.
How the flat rate scheme works
Under the flat rate scheme you still charge customers VAT at the normal rate, but you pay HMRC a fixed percentage of your VAT-inclusive turnover. You keep the difference between what you charge and what you pay over. You cannot reclaim VAT on purchases, apart from certain capital assets over £2,000. In your first year as a VAT-registered business, you get a 1% discount.
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If you are unsure about tax, bookkeeping, payroll, property accounts or business finances, speak to the team at FHP Accounting for clear, practical guidance.
GOV.UK gives a simple illustration. You bill a customer £1,000 plus £200 of VAT, so £1,200 in total. If you are a photographer with an 11% rate, you pay HMRC 11% of £1,200, which is £132. You keep the other £68 of the VAT you charged.
The percentage depends on your type of business. A few examples from HMRC’s list are below.
| Example | Flat rate mentioned |
|---|---|
| Photographer | 11% |
| IT rate, if the consultant qualified | 14.5% |
| Limited cost business | 16.5% |
The difference you keep is still income. It belongs in your annual statutory accounts and is taxed through your company tax returns or personal return, so do not treat it as a free bonus.
When the limited cost rate applies
If your spending on goods is small, you must use a flat rate of 16.5% whatever your trade. You are a limited cost business if your goods cost less than 2% of your VAT-inclusive turnover, or less than £1,000 a year if that is more than 2%. At 16.5%, the scheme takes most of the VAT you charge.
HMRC’s online checker applies this test to each VAT return period, so a quiet quarter with few purchases can push you onto 16.5% for that return alone. Services, software and most food and vehicle costs do not count as goods, so a laptop and a few subscriptions will not save you.
Here is how it plays out for 2 businesses, ignoring the first-year discount.
The consultant’s standard VAT is £12,000 charged less £700 reclaimed. The salon’s is £12,000 less £1,200. For the flat rate, both pay a percentage of £72,000, which is their sales including VAT. If the consultant had qualified for the 14.5% IT rate instead, they would have paid £10,440, so the limited cost rule is what turns a saving into a loss.
Before you apply, run both calculations on your real figures from the last 12 months. Many freelancers assume the scheme saves them money and never check.
Cash accounting: pay VAT when customers pay you
Cash accounting means you pay VAT on sales when your customers pay you, and reclaim VAT on purchases when you pay your suppliers. It helps businesses that wait for payment, because you never fund VAT out of your own pocket on invoices that are still unpaid. It also means you never pay VAT on a debt that is never paid.
Say you invoice £6,000 plus £1,200 of VAT in March and the customer pays in June. Under standard accounting, that £1,200 goes on your March quarter return even though you have not been paid. Under cash accounting it goes on the return covering June.
The downside is that you can only reclaim VAT on your own purchases once you have paid for them. There are also limits. You cannot use cash accounting for invoices with payment terms of 6 months or more, invoices raised in advance, or hire purchase and credit sale deals. You must be up to date with your returns and payments, and you must leave if turnover passes £1.6 million.
The GOV.UK cash accounting guidance confirms you can join at the start of a VAT accounting period without telling HMRC. When you leave, you report and pay any outstanding VAT, though you can spread it over 6 months in most cases.
Annual accounting: submit one VAT return a year
With annual accounting you make advance payments towards your VAT bill, then submit 1 VAT return a year with a final balancing payment. It suits businesses with steady, predictable VAT bills and a dislike of quarterly deadlines. It is a poor fit if you regularly reclaim VAT, because you only get 1 refund a year.
You can choose 9 monthly payments of 10% of your estimated bill, due at the end of months 4 to 12, or 3 quarterly payments of 25%, due at the end of months 4, 7 and 10. The return and final payment are normally due within 2 months of the end of the year. The details are in the GOV.UK annual accounting guidance.
Annual accounting does not remove your Making Tax Digital obligations. You still need digital records and compatible software, and a platform like Xero bookkeeping can handle that, including VAT in Xero.
Flat rate and annual accounting can usually be used together, but cash accounting cannot be used with the flat rate scheme, because the flat rate has its own cash-based turnover method.
Questions to ask before choosing a scheme
Ask yourself these questions before you decide:
- Do You Buy Much In The Way Of Goods
- Do Customers Pay You Slowly
- Do You Reclaim VAT Most Quarters
- How Close Are You To £150,000 Or £230,000
- Would One Return A Year Cause Cash Flow Problems
If your answer to the first question is “not much”, the flat rate scheme is probably a poor fit. If your answer to the second is “yes”, cash accounting is worth a look. If you answer “most quarters” to the third, avoid annual accounting.
New businesses should think about this before they register. Our accountants for start-ups can model the options as part of your registration. If you want ongoing help once you are registered, our VAT return services team handles the returns and scheme reviews, and good bookkeeping keeps the figures clean if HMRC asks for them.
Joining, leaving and reviewing your scheme
To join the flat rate scheme, you apply to HMRC. You can leave at any time, and you must leave if you are no longer eligible. After leaving, you have to wait 12 months before rejoining. Cash accounting and annual accounting have their own joining and leaving rules, so check them before you switch.
Review your scheme once a year. A scheme that suited you at £50,000 of turnover can stop suiting you at £140,000, especially if your costs change.
FAQs
Is the flat rate scheme worth it?
It can be if you buy a reasonable amount of goods and your trade rate is well below 16.5%. For many service businesses on the limited cost rate it is not, so compare it with standard VAT on your own figures.
Who can join the flat rate scheme?
You can join if you expect VAT taxable turnover of £150,000 or less excluding VAT in the next 12 months. You normally have to leave once your turnover including VAT goes above £230,000.
Can I use cash accounting with the flat rate scheme?
No. HMRC does not allow cash accounting if you use the flat rate scheme.
Can I reclaim VAT on purchases under the flat rate scheme?
Generally not. The exception is capital assets over £2,000, which you can still reclaim VAT on.
Can I leave the flat rate scheme?
Yes, you can choose to leave at any time by contacting HMRC. You then have to wait 12 months before you can rejoin.
Get help choosing a VAT scheme
The right VAT scheme comes down to your costs, your customers and your growth plans. A short comparison on your own figures usually settles it. If you would like us to run it for you, get in touch or call 0115 648 8686.
I lead FHP Accounting, an accountancy practice specialising in Commercial and Residential Property Accounting. Our goal is to make the administration of running property portfolios easier for landlords, managers, and investors — allowing you to focus on what you do best, while we take care of everything behind the scenes.
Need Expert Accounting Advice?
If you are unsure about tax, bookkeeping, payroll, property accounts or business finances, speak to the team at FHP Accounting for clear, practical guidance.
