Once you’ve registered for VAT, you face a second decision that’s less obvious but just as important: which VAT scheme do you use? The choice between the Flat Rate Scheme and the standard scheme affects how much tax you pay, how much paperwork you do, and whether you can reclaim VAT on your business costs.
The decision isn’t obvious. The Flat Rate Scheme is simpler and can leave you keeping more of the VAT you collect — but only if your costs are low enough. The standard scheme means more record-keeping but lets you reclaim every penny of input VAT. And the “limited cost trader” rule means many service-based sole traders are forced onto a punitive 16.5% rate that makes the FRS worse than standard accounting.
This guide covers how each scheme works, the 2026/27 rates, the limited cost trader trap, and a worked example so you can see which one actually saves you money. For the broader question of whether to register for VAT at all, see our VAT registration guide.
How the Standard VAT Scheme Works
The standard scheme is the default. According to HMRC’s VAT guide (Notice 700), the basic mechanics are:
- You charge 20% VAT on your sales (output VAT).
- You pay 20% VAT on your business purchases (input VAT).
- You reclaim the input VAT on your VAT return.
- You pay HMRC the difference: output VAT minus input VAT.
If your input VAT exceeds your output VAT in a period, HMRC refunds you the difference.
What you can reclaim
According to HMRC’s guidance on reclaiming VAT on business expenses, you can reclaim VAT on most legitimate business purchases:
- Stock and inventory
- Equipment and machinery
- Business services (accountancy, legal, software)
- Office costs (rent, utilities, stationery)
- Fuel and vehicle costs (subject to rules on private use)
You cannot reclaim VAT on:
- Business entertainment (for sole traders and partnerships)
- Personal expenses
- Goods or services used for exempt supplies
The record-keeping burden
Under the standard scheme, you must track VAT on every single transaction — every sale and every purchase. According to HMRC’s VAT return guidance (Notice 700/12), you report:
- Box 1: VAT due on sales (output VAT)
- Box 4: VAT reclaimed on purchases (input VAT)
- Box 7: Total value of purchases and other inputs
Under Making Tax Digital for VAT, all of this must be done through MTD-compatible software — you can’t just keep a spreadsheet by itself.
How the Flat Rate Scheme Works
The Flat Rate Scheme (FRS) simplifies VAT accounting. Instead of tracking VAT on every transaction, you pay HMRC a fixed percentage of your gross (VAT-inclusive) turnover. You still charge customers 20% — the difference between what you collect and what you pay to HMRC is yours to keep.
According to HMRC’s Flat Rate Scheme guidance (VAT Notice 733), the scheme is designed to simplify record-keeping: you don’t need to track input VAT on individual purchases, and the VAT due is a simple percentage calculation.
The calculation
Gross turnover × flat rate percentage = VAT due to HMRC
For example, if your gross turnover is £10,000 and your flat rate is 14.5%:
- VAT due to HMRC: £10,000 × 14.5% = £1,450
- VAT you charged customers: £10,000 × 20/120 = £1,666.67
- You keep: £1,666.67 - £1,450 = £216.67
That £216.67 is the “profit” from the FRS — the difference between what you charged and what you paid. Under the standard scheme, you’d owe HMRC the full £1,666.67 minus whatever input VAT you could reclaim.
The flat rate percentages
Your flat rate depends on your business sector. According to HMRC’s A-Z list of flat rate percentages (FRS7300), common rates include:
| Business sector | Flat rate |
|---|---|
| Accountancy or bookkeeping | 14.5% |
| Computer and IT consultancy or data processing | 14.5% |
| Management consultancy | 14% |
| General building or construction (with materials) | 9.5% |
| General building or construction (labour-only) | 14.5% |
| Hairdressing or beauty treatment | 13% |
| Advertising | 11% |
| Catering (restaurants and takeaways) | 12.5% |
| Retail (food/drink) | 7.5% |
| Farming or agriculture | 6.5% |
| Any other activity not listed | 12% |
| Limited cost trader (default) | 16.5% |
You choose the sector that most closely describes your business activity. If you’re not sure which sector applies, HMRC’s flat rate calculator can help.
The first-year discount
New VAT registrants get a 1% reduction on their flat rate for the first 12 months from registration. An IT consultant on 14.5% pays 13.5% in year one. This makes the FRS more attractive in the first year — but the discount expires after 12 months, so run the numbers for year two onwards as well.
What you can’t reclaim
Under the FRS, you cannot reclaim VAT on purchases — with one exception: capital assets costing £2,000 or more (including VAT). For these, you can reclaim the VAT even on the FRS.
This is the key trade-off. If you have significant VAT-bearing costs, the inability to reclaim input VAT can cost you more than the FRS saves.
The Limited Cost Trader Trap
This is the rule that catches most service-based sole traders — and the reason the FRS is no longer the automatic choice it once was.
According to HMRC’s guidance on how much you pay, you’re classified as a limited cost business if your spending on relevant goods is either:
- Less than 2% of your VAT flat rate turnover, or
- Greater than 2% but less than £1,000 per year
If you’re a limited cost trader, you must use the 16.5% flat rate — the highest available — regardless of your sector.
What counts as “relevant goods”
“Relevant goods” means physical goods used exclusively for the business. It explicitly excludes:
- Vehicles, vehicle parts, and fuel
- Food and drink for consumption
- Services (accountancy, legal, software, etc.)
- Items that aren’t stock or equipment
This means most service-based sole traders — consultants, freelancers, IT contractors, designers — are almost certain to be limited cost traders. Their main costs are services (software subscriptions, professional fees) and items that don’t count as relevant goods (laptops, which are capital assets, not stock).
Why 16.5% is punitive
At 16.5% of gross turnover, you’re paying almost as much as you collect:
- VAT charged to customers: 20/120 = 16.67% of gross
- FRS rate for limited cost traders: 16.5% of gross
- You keep: 16.67% - 16.5% = 0.17% of gross
On £100,000 of gross turnover, you keep just £170 from the FRS — while paying £16,500 to HMRC. Under the standard scheme, you’d owe £16,667 in output VAT minus whatever input VAT you could reclaim. If you can reclaim more than £170 in input VAT (and almost any business can), the standard scheme is better.
Flat Rate Scheme vs Standard: The Decision Framework
When the Flat Rate Scheme wins
The FRS is better when:
- Your costs are genuinely low. You’re a pure service business with minimal VAT-bearing purchases — no stock, no materials, no significant equipment.
- You’re NOT a limited cost trader. You spend more than 2% of turnover on relevant goods AND more than £1,000/year. This is rare for service businesses.
- Your sector rate is low. A builder with materials at 9.5% or a farmer at 6.5% keeps a large margin between the 20% charged and the rate paid.
- You value simplicity over optimisation. The FRS genuinely reduces record-keeping — you don’t need to track input VAT on every purchase.
When the Standard Scheme wins
The standard scheme is better when:
- You’re a limited cost trader. At 16.5%, the FRS is almost always worse than standard accounting, where you can reclaim input VAT on services, software, fuel, and other costs that don’t count as “relevant goods.”
- You have significant VAT-bearing costs. Stock, materials, equipment, fuel, and services with VAT — all of these can be reclaimed under the standard scheme but not under the FRS.
- Your turnover exceeds £150,000. You can’t join the FRS above this threshold.
- You expect to grow past £230,000. You’ll have to leave the FRS anyway, and switching mid-stream creates extra admin.
The break-even calculation
The simplest way to decide: compare what you’d pay under each scheme.
Under the FRS: Gross turnover × flat rate percentage
Under the standard scheme: Output VAT (20% of net sales) - Input VAT (VAT reclaimed on purchases)
The FRS wins when: Gross turnover × flat rate < Output VAT - Input VAT
Rearranging: the FRS wins when your input VAT is less than (Output VAT - Gross × flat rate).
For a limited cost trader at 16.5%:
- Output VAT - Gross × 16.5% = Gross × 16.67% - Gross × 16.5% = Gross × 0.17%
- So the FRS only wins if your input VAT is less than 0.17% of your gross turnover — effectively nothing.
For an IT consultant at 14.5% (not a limited cost trader):
- Output VAT - Gross × 14.5% = Gross × 16.67% - Gross × 14.5% = Gross × 2.17%
- The FRS wins if your input VAT is less than 2.17% of your gross turnover.
Worked Example: IT Consultant vs Builder
Let’s compare two sole traders, both with £100,000 of gross (VAT-inclusive) turnover.
Scenario 1: IT Consultant
An IT consultant with £100,000 gross turnover. Their costs are software subscriptions (£2,400/year, all VAT-bearing) and a laptop (£1,500, capital asset). They’re a limited cost trader because they spend almost nothing on “relevant goods.”
Under the FRS (16.5% as limited cost trader):
- VAT due: £100,000 × 16.5% = £16,500
- VAT kept: £16,667 - £16,500 = £167
Under the standard scheme:
- Output VAT: £16,667
- Input VAT reclaimed: VAT on software (£400) + VAT on laptop (£250) = £650
- VAT due: £16,667 - £650 = £16,017
- Net position vs FRS: £16,500 - £16,017 = £483 better off
The standard scheme wins by £483 — and the gap widens as costs increase.
Scenario 2: Builder with Materials
A builder with £100,000 gross turnover. Their costs include £20,000 of building materials (all VAT-bearing). They’re NOT a limited cost trader because materials are more than 2% of turnover and more than £1,000/year. Their sector rate is 9.5%.
Under the FRS (9.5%):
- VAT due: £100,000 × 9.5% = £9,500
- VAT kept: £16,667 - £9,500 = £7,167
Under the standard scheme:
- Output VAT: £16,667
- Input VAT reclaimed: VAT on materials (£3,333) + other costs (£500) = £3,833
- VAT due: £16,667 - £3,833 = £12,834
- Net position vs FRS: £12,834 - £9,500 = £3,334 worse off
The FRS wins by £3,334 — because the builder’s sector rate (9.5%) is so much lower than the 20% they charge, and their input VAT (£3,833) is less than the gap between output VAT and the FRS payment (£7,167).
The pattern
The FRS works when your sector rate is low enough that the gap between 20% and your rate exceeds your input VAT. Builders, farmers, and retailers with low sector rates can benefit. Service businesses with high sector rates (14.5%) or the 16.5% limited cost trader rate almost always do better on the standard scheme.
Eligibility and Joining
Who can join the FRS
According to HMRC’s Flat Rate Scheme guidance, you can join if:
- You’re already VAT-registered
- Your taxable turnover (excluding VAT) is £150,000 or less in the next 12 months
- Your business is not “associated” with another business (complex group structures may be excluded)
When you must leave
You must leave the FRS if your VAT-inclusive turnover exceeds £230,000 in any 12-month period. You must notify HMRC and leave within 30 days of the end of the period in which you exceeded the limit. Once you leave, you cannot rejoin for 12 months.
You can also leave voluntarily at any time by contacting HMRC through your VAT online account.
How to join
You can join the FRS through your VAT online account or by completing form FRV1. The scheme starts from the beginning of the VAT period in which you apply — it’s not backdated.
How MTD Affects Both Schemes
Both the FRS and the standard scheme require Making Tax Digital for VAT compliance. All VAT-registered businesses must keep digital records and submit VAT returns through MTD-compatible software.
Under the FRS, your digital record-keeping is simpler — you don’t need to record input VAT on every purchase, just your gross sales and the flat rate calculation. Under the standard scheme, you need to record VAT on every transaction.
Either way, you’ll need MTD-compatible software — see our guide for the cheapest options.
The Bottom Line
- The FRS simplifies record-keeping but doesn’t always save money. Simplicity has a cost — you can’t reclaim input VAT.
- Limited cost traders pay 16.5% — the highest rate. If you spend less than 2% of turnover on relevant goods or under £1,000/year, the FRS is almost always worse than standard accounting.
- The FRS wins when your sector rate is low and your costs are low. Builders at 9.5%, farmers at 6.5%, and retailers at 7.5% can benefit. Service businesses at 14.5% rarely do.
- The standard scheme wins when you have significant VAT-bearing costs. Stock, materials, equipment, and services with VAT can all be reclaimed.
- The first-year 1% discount helps, but it expires. Run the numbers for year two onwards before joining.
- Eligibility: £150,000 to join, £230,000 to leave. You can’t join above £150,000 turnover, and you must leave at £230,000.
- Both schemes require MTD-compatible software. The FRS reduces what you record, but you still need digital record-keeping.
- Run the numbers before joining. Don’t assume the FRS is cheaper just because it’s simpler. The break-even calculation takes 5 minutes and can save you thousands.
For the broader question of whether to register for VAT at all, see our VAT registration guide. For the cheapest MTD-compatible software options, see our MTD software comparison. For the full MTD rules, see our Making Tax Digital guide.