Flat Rate Scheme: test the goods before choosing the VAT percentage
At the end of a VAT quarter, a small business on the Flat Rate Scheme has £1,720 of purchases on its ledger and £12,000 of VAT-inclusive turnover. The expense total looks well above the limited cost figures, but only £220 of it counts. The test uses qualifying goods and flat-rate turnover for the same return period, and the result decides whether the business uses 16.5% or its sector rate.
Two figures for each return period
HMRC's test compares relevant goods, including VAT, with 2% of flat-rate turnover and the proportion of £1,000 for the return period. For a quarterly return, that proportion is £250. Flat-rate turnover includes VAT and may include exempt supplies.
A business is limited cost when relevant-goods spending is less than the higher of 2% of flat-rate turnover and the relevant proportion of £1,000. Spending exactly equal to the higher figure is not below it. A limited cost business uses 16.5%, reduced by one percentage point where the first-year VAT registration reduction applies. The result can change from one return to the next, so a business can move between the limited cost and sector rates.
Spending more than £250 does not settle the question. In a hypothetical quarter with £30,000 of turnover, 2% is £600, so £300 of qualifying goods clears the £250 figure but misses the £600 figure.
What the goods test leaves out
Relevant goods must be used exclusively for the business. Much of a normal expense ledger falls outside that definition, including:
- Services, including downloaded software, advertising, rent and accountancy fees.
- Capital expenditure goods of any value.
- Food and drink for staff, and promotional gifts.
- Most vehicle and fuel costs, with an exception for transport businesses using their own or leased vehicles.
- Goods for resale or hire, unless those are ordinarily the main business activity.
- Goods stockpiled solely to meet the test that the business cannot use.
Sources and context, checked :
A hypothetical quarter
Assume an established business outside its first-year reduction has £12,000 of flat-rate turnover including VAT and treats its laptop as a capital expenditure item.
The test figures are £240, which is 2% of turnover, and the £250 quarterly proportion. The £220 of relevant goods is below both, so the business applies 16.5%: £12,000 × 16.5% = £1,980 payable. In a comparison quarter with £280 of qualifying goods on the same turnover, the goods clear both figures and the business uses its sector rate, assuming nothing else changes.
| Purchase | Amount | Counts as relevant goods? |
|---|---|---|
| Stationery and cleaning goods for business use only | £220 | Yes |
| Downloaded software and accountancy fees | £900 | No, these are services |
| Laptop | £600 | No, it is a capital expenditure item |
| Total expenses | £1,720 | £220 counts |
Read the percentage correctly
The 16.5% applies to VAT-inclusive turnover, so it cannot be compared directly with 20% of net sales. HMRC warns that limited cost traders may pay more than under standard VAT accounting, so the scheme does not necessarily save VAT.
The laptop's exclusion from the goods test is also separate from the scheme's input VAT rule. Normal purchases generally give no separate input VAT claim, but there are limited exceptions, such as qualifying capital expenditure goods costing £2,000 or more including VAT. Those goods still stay out of the limited cost test.
Sources and context, checked :
Make the test repeatable
Keep the working with each return so the rate can be traced to that period's figures. An annual average will not show why a particular quarter used a particular rate.
- Build a goods-only schedule for the return period and mark each excluded purchase.
- Reconcile VAT-inclusive turnover to the scheme definition.
- Keep both threshold calculations and the rate selected for that period.