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Flat Rate VAT for contractors

As a freelance contractor working through your own limited company, it's easy to get bogged down with the mountain of paperwork and statutory obligations you need to adhere to.

One of the more confusing aspects of these requirements is accounting for VAT - which is why HMRC has made flat rate VAT an option for small businesses, contractors and freelancers.

The goal of the flat rate VAT scheme is to reduce the amount of effort necessary to track and claim your input VAT costs (the VAT element of your business expenses).

For years, accountants and bookkeepers would turn an unsightly shade of grey at the prospect of sorting through a client's VAT receipts - most of which were stained in coffee or half chewed by the dog. Fortunately, such chores are no longer necessary with the introduction of the flat rate VAT scheme

So what are the conditions of using flat rate VAT?

Well, unfortunately you cannot switch between the standard method of accounting for VAT and the flat rate scheme whenever you wish, or whenever a return is due. To use the flat rate VAT, you must first submit an application to HMRC - and your company must not have been using the flat rate VAT scheme within the previous twelve months. Your company's income is also required to be under £150,000 before VAT and £187,500 VAT-inclusive.

The scheme itself is incredibly easy to administer and requires nothing more than a basic understanding of the 'chargeable' and 'payable' percentages. Therefore, once you receive confirmation from HMRC of your acceptance onto the flat rate VAT scheme, the time taken to file your VAT returns is significantly reduced - don't forget, that should also mean less billable hours from your accountant or bookkeeper.

So how do I calculate Flat Rate VAT?

In essence, rather than accounting for the exact amount of your VAT expenses in the accounting period, you must only account for gross receipts (or invoices) that have been charged to your clients (including VAT) and calculate the appropriate percentage to pay over to HMRC. For example, at the time of writing, most IT contractors will charge 15% VAT to their clients, but only pay 11.5% to HMRC on the flat rate VAT scheme.

This is calculated as follows:-

Net Invoice (excluding VAT) billable to client = £1,000
Gross Invoice (including VAT) billable to client = £1,150

VAT Payable to HMRC = 11.5% of £1,150 = £132.25

Once you become more familar with the concept of using flat rate vat, you'll soon see it's enormous advantages in both time and money - as long as your company remains eligible. Furthermore, in the event that you make a large capital investment... anything over £2,000... you can still deduct the VAT paid on your return.

If you still aren't convinced, you may be interested to hear that there is currently an additional incentive to sign up for the flat rate vat scheme. For the first 12 months, you are given a 1% reduction in the rate payable to HMRC as a sweetener for joining (so that's now 10.5% for IT contractors).

Our advice is to ask about - talk to your accountant or do the numbers yourself. If they make happy reading then go for it. Just think of what you could be doing with all that time you'll save?

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