Contractors’ Questions: How to work out my Flat Rate VAT saving?

Contractor’s Question: I’m a bit confused about VAT – and how the Flat Rate Scheme works, partly as I’m only in my first year of VAT registration.

Before my accountant went on holiday, he sent me a calculation showing my gross income as £81,120. I know how he arrived at the figure of £80,000 – because that’s how much I’ve billed my client for, excluding VAT, in the last year.

But the additional £1,120 is mystifying to me, as the Flat Rate for my sector is 16.5% -- a percentage that doesn’t seem to correlate with the £1,120, which the accountant signalled is apparently my Flat Rate VAT saving. Any advice before his return would be appreciated.

Expert’s Answer: Before we get into those specific figures, it might help you to remember that if you're using the VAT Flat Rate scheme, your expenses will be inclusive of VAT, but your sales net of standard VAT. Crucially, if it’s your first time with these calculations, bear in mind that the difference between the Flat Rate and Standard Rate from your sales will be your surplus.

But equally crucial during your first time doing these sums, you get from HMRC a 1% discount on your trade percentage as it's your first year of being registered for VAT. This discount applies not in your first year of trading or of being on the VAT Flat Rate Scheme; it applies in your first year of being registered for VAT.

That means that, if you are a ‘limited cost’ trader with a percentage of 16.5%, for your first year of registration you would use 15.5% instead. HMRC confirms this in their guidance here, in paragraph 4.7

Turning to the numbers you provide, the £1,120 figure seems correct. The Flat Rate saving is calculated on the difference between what you would charge at standard VAT of 20% to your end-client and then subsequently you pay 15.5% VAT (on the gross figure) to HMRC.

So in cash terms, the £80,000 in sales will attract VAT of £16,000 (due to VAT being charged at a standard rate of 20%), giving an invoice total of £96,000. Then you will pay to HMRC a sum of £14,880 in VAT. This equates to 15.5% applied to the VAT inclusive sum of £96,000. So the bottom-line is that you achieved a £1,120 saving, which forms part of the company’s profits.

If you’re still unsure, you might need to double-check so either wait until your accountant returns from his holiday or ask one of his colleagues (assuming he doesn't work on his own). Good luck!

The expert was Emily Coltman FCA, chief accountant at FreeAgent, an accounting platform for freelancers, contractors and the self-employed.