VAT Schemes Compared: Standard, Flat Rate, Cash Accounting, Annual

The Four Main VAT Schemes

When you register for VAT, you don't have to use the default standard accounting method. HMRC offers several alternative schemes designed to help small businesses manage their VAT obligations more easily. Here's how they compare.

Standard VAT Accounting

How it works: You account for VAT when you issue an invoice (output tax) and when you receive a purchase invoice (input tax), regardless of when payment actually happens.

Returns: Quarterly

Best for: Businesses with regular cash flow, businesses that pay their suppliers before their customers pay them, businesses with significant reclaimable VAT on purchases.

Advantages:

• Full input VAT recovery on all eligible purchases
• Straightforward and well-understood
• No turnover limits

Disadvantages:

• You may owe VAT on invoices your customers haven't paid yet
• Quarterly returns require regular administration

Flat Rate Scheme (FRS)

How it works: You charge customers VAT at 20% but pay HMRC a fixed percentage of your gross turnover. The percentage depends on your industry.

Returns: Quarterly

Turnover limit: £150,000 (excluding VAT) to join

Best for: Service businesses with low expenses, businesses wanting simpler administration, businesses whose flat rate percentage is well below 20%.

Advantages:

• Much simpler record-keeping
• Potential to keep the difference between 20% and your flat rate
• 1% discount in your first year of VAT registration

Disadvantages:

• Cannot reclaim input VAT on purchases (except capital goods over £2,000)
• Limited cost trader rule (16.5%) catches many service businesses
• May cost more than standard VAT if you have high reclaimable expenses

See our detailed guide on the Flat Rate Scheme.

Cash Accounting Scheme

How it works: You account for VAT based on when you receive and make payments, not when invoices are issued.

Returns: Quarterly

Turnover limit: £1,350,000 to join

Best for: Businesses with slow-paying customers, businesses wanting to align VAT payments with cash flow.

Advantages:

• Don't owe VAT until your customer actually pays you
• Automatic bad debt relief (if a customer never pays, you never account for the VAT)
• Better cash flow management

Disadvantages:

• Can't reclaim input VAT until you've paid your suppliers
• More complex record-keeping than flat rate
• Must leave if turnover exceeds £1,600,000

Annual Accounting Scheme

How it works: You submit one VAT return per year instead of four, making advance payments during the year based on estimated liability.

Returns: Annually (one return per year)

Turnover limit: £1,350,000 to join

Best for: Businesses wanting fewer returns, businesses with predictable turnover, businesses that prefer to budget VAT payments through the year.

Advantages:

• Only one return per year to prepare
• Nine monthly payments spread through the year (or three quarterly)
• More time to prepare your annual return
• Easier budgeting with predictable payments

Disadvantages:

• Advance payments may exceed what you actually owe, tying up cash
• Less frequent opportunity to reclaim input VAT
• Must leave if turnover exceeds £1,600,000

Can You Combine Schemes?

Some combinations are possible:

| Combination | Allowed? | |-------------|----------| | Flat Rate + Annual Accounting | Yes | | Flat Rate + Cash Accounting | No (FRS has its own cash-based option) | | Cash Accounting + Annual Accounting | No | | Standard + Cash Accounting | Yes (cash accounting is a variant of standard) | | Standard + Annual Accounting | Yes |

Quick Decision Guide

Low expenses, service business? Consider Flat Rate Scheme (but check the limited cost trader rule).

Slow-paying customers? Consider Cash Accounting Scheme.

Want fewer returns? Consider Annual Accounting Scheme.

High reclaimable expenses? Stick with Standard VAT Accounting.

Not sure? With Accounted, Penny can model your actual transactions under each scheme and show you which saves the most.

Choose the right VAT scheme for your business. Start your free trial with Accounted and get personalised recommendations.