Should You Use the VAT Flat Rate Scheme in 2026?

The VAT Flat Rate Scheme (FRS) was designed to simplify VAT for small businesses — but in 2025, it’s not always the most tax-efficient option. While it can reduce admin, changes in trading patterns, costs, and digital accounting mean some businesses may actually pay more VAT under the scheme.

In this blog, we’ll explain how the Flat Rate Scheme works, who qualifies, how to calculate VAT under it, and when it’s time to reconsider your position.

What Is the VAT Flat Rate Scheme?

The Flat Rate Scheme (FRS) lets small VAT-registered businesses pay a fixed percentage of their gross turnover to HMRC, instead of reclaiming input VAT on each purchase.
You still charge VAT to your customers at the standard rate (e.g. 20%), but when you file your VAT return, you pay HMRC a lower percentage based on your business sector.

This means:

• You keep the difference between what you charge (20%) and what you pay to HMRC (the flat rate).
• You can’t usually reclaim input VAT on most purchases (except for certain capital assets over £2,000).

Who Can Use the Flat Rate Scheme?

To qualify, your business must:

• Have expected VATable turnover of £150,000 or less (excluding VAT) in the next 12 months.
• Not be closely associated with another business (i.e., no artificial separation).
• Not have been in the scheme and left it in the past 12 months.

You must leave the scheme if:

• Your total business income exceeds £230,000 (including VAT) in the previous 12 months, or
• You expect your turnover to exceed that level in the next 30 days.

Flat Rate Percentages by Sector

Each industry has its own flat rate percentage — for example:

(Rates are subject to HMRC updates — always confirm the latest percentages in VAT Notice 733.)

Newly registered businesses get a 1% discount on their flat rate for the first 12 months.

What Is a “Limited Cost Trader”?

Since 2017, many small businesses have been caught by the limited cost trader (LCT) rule — introduced to stop service-based businesses benefiting unfairly.

You’re a limited cost trader if the value of your goods bought (excluding capital items, food, vehicles etc) is:

• Less than 2% of your turnover, or
• Less than £1,000 a year (if your turnover is over £50,000).

If you’re a limited cost trader, you must use a flat rate of 16.5%, regardless of your business sector — which significantly reduces the benefit of the scheme.

Example: How the Flat Rate Scheme Works

Let’s say you run an IT consultancy business which bills £60,000 + VAT (£72,000 gross) a year.
Your sector flat rate is 14.5%.

• You charge clients £72,000
• You pay HMRC 14.5% of £72,000 = £10,440
• You keep the difference (£12,000 – £10,440 = £1,560), which represents your retained VAT margin

However, if your input VAT on purchases exceeds roughly £1,560 per year, you’d be better off on standard VAT accounting.

If the business in the above example was a low cost trader the payment due to HMRC would be 16.5% of £72,000 = £11,880 so difference kept would only be £120 (£12,000 – £11,880).

The Benefits of the Flat Rate Scheme

Simplified VAT accounting — you don’t need to track input VAT on every purchase.
Predictable VAT payments — easy to budget for.
Potential cash flow benefit — if your input VAT is low.
MTD compatible — can still be filed digitally via your software.

Drawbacks and Risks

Limited VAT recovery — you can’t usually reclaim VAT on expenses.
Limited Cost Trader trap — service businesses often lose any advantage.
Not always cheaper — many businesses pay more VAT overall under FRS.
Harder to reflect changes — if your cost base grows, the scheme may become inefficient.

When the Flat Rate Scheme Makes Sense

The Flat Rate Scheme can still work well if:

• You have low overheads and minimal VATable expenses.
• You’re a new or micro business wanting simplicity.
• You don’t buy or import many goods.
• You qualify for the 1% new business discount.

When to Avoid or Leave the Scheme

Consider standard VAT accounting if:

• You incur significant VAT on costs.
• You are a limited cost trader.
• You deal with zero-rated or exempt supplies.

How to Join or Leave the Scheme

To join, apply via your VAT online account or by completing Form VAT600FRS.
To leave, you can opt out voluntarily or must do so if you exceed the turnover threshold.

Once you leave, you revert to standard VAT accounting — remember to adjust for any advance payments or invoices that span your exit date.

Should You Use the Flat Rate Scheme in 2026?

In 2026, the Flat Rate Scheme remains useful for some small businesses, but not most.
With rising costs, digital record-keeping, and tighter margins, many find that standard VAT accounting gives more control and better cash flow results.

The right choice depends on your turnover, input costs, and growth plans — so a review every year is good practice.

Need Expert VAT Advice?

Our VAT specialists help businesses review their VAT schemes, model the potential savings, and ensure full HMRC compliance.
If you’re unsure whether the Flat Rate Scheme is right for your business contact us for a review.