The VAT Flat Rate Scheme has been designed to simplify the way a business accounts for VAT and in so doing reduce the administration costs of complying with the VAT legislation. The scheme is open to businesses that expect their annual taxable turnover in the next 12 months to be no more than £150,000.

A limited cost trader check was introduced in April 2017 and can increase the VAT flat rate percentage used by VAT registered businesses that use the Flat Rate scheme. If you meet the definition of a 'limited cost trader' you are required to use a fixed rate of 16.5%. The highest 'regular' rate is 14.5%.

A limited cost trader is defined as one whose VAT inclusive expenditure on goods is either:

• less than 2% of their VAT inclusive turnover in a prescribed accounting period;
• greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).

For some businesses – for example, those who purchase no goods, or who make significant purchases of goods – the outcome of the test will be self-evident. Other businesses need to complete a simple test, using information they already hold, to work out whether they need to use the higher 16.5% rate. If so, the use of the flat rate scheme will probably not be beneficial.

When you issue an invoice to your customer, you must ensure that you charge the correct rate of VAT. Whilst most businesses in the UK charge VAT at the standard rate of 20% there are a number of different VAT rates and exemptions that you should be aware of. 

In the UK, there are three separate VAT rates, the standard rate @ 20%, the reduced rate @ 5% and the zero rate @ 0%.

There are special rules when charging VAT where there are discounts or free gifts. The rules are complex, but we have summarised the main aspects below.

Discounts and free gifts

Offer	How to charge VAT
Discounts	Charged on the discounted price (not the full price)
Gifts	Charged on the gift’s full value. There are some specific exceptions on gifts given to the same person if their total value in a 12-month period is less than £50.
Multi-buys	Charged on the combined price if all the items have the same VAT rate. If not, VAT is ‘apportioned’ as mixed-rate goods
Money-off coupons, vouchers etc	No VAT due if given away free at time of a purchase. If not, VAT due on the price charged
‘Face value’ vouchers that can be used for more than one type of good or service	‘Face value’ vouchers that can be used for more than one type of good or service No VAT due, if sold at or below their monetary value
Redeemed face value vouchers	Charged on the full value of the transaction
Redeemed face value vouchers sold at a discount	Charged on the discounted value of the transaction
Link-save offers (buy one get one free or discounted)	VAT is apportioned as mixed-rate goods – there are exceptions

VAT for most work on houses and flats by builders and similar trades, like plumbers, plasterers and carpenters, is charged at the standard rate of 20%. However, there are a number of exceptions where special VAT rules apply and a reduced or zero rate of VAT may apply. 

A builder may not have to charge VAT (zero rate) on some types of work if it meets certain conditions, including:

• building a new house or flat
• work for disabled people in their home

A builder may be able to charge the reduced rate of 5% for some types of work if it meets certain conditions, including:

• installing energy saving products and certain work for people over 60
• converting a building into a house or flats or from one residential use to another
• renovating an empty house or flat
• home improvements to a domestic property on the Isle of Man

There are also special VAT rules for work on certain types of buildings that are not houses or flats, including approved alterations and substantial reconstructions to protected buildings and converting a non-residential building into a house or communal residential building for a housing association. 

In addition, there are certain other types of communal residential building that builders do not have to charge VAT. These include children’s homes, residential care homes, hospices and student accommodation.

In all cases, it is the supplier’s responsibility to charge VAT correctly and to ensure they hold proper evidence to support the fact that a customer is eligible for a supply at the reduced or zero VAT rate.

For most fully taxable businesses, VAT can be reclaimed on goods and services used in the course and furtherance of their business activities. This means that businesses must consider where there is personal or private use of goods or services bought for the business and can usually only reclaim the business proportion of any VAT charged.

For example, VAT is recoverable on all the costs of mobile phones provided to employees where no personal use is allowed. Where businesses allow private calls to be made at no charge the VAT recovery must be apportioned on a fair and reasonable basis. Where employees pay for the private use of their phones the business is allowed to reclaim the input tax in full provided an output tax charge is accounted for in respect of private use.

You cannot reclaim VAT for:

• anything that is only for private use;
• goods and services your business uses to make VAT-exempt supplies;
• business entertainment costs;
• goods sold to you under one of the VAT second-hand margin schemes;
• business assets that are transferred to you as a going concern.

There are different rules for a business that incurs expenditure on taxable and exempt business activities. These businesses are partially exempt for VAT purposes and are required to make an apportionment between their activities using a 'partial exemption method' in order to calculate how much input tax is recoverable.

A business that incurs expenditure on taxable and exempt business activities is partially exempt for VAT purposes. This means that the business is required to make an apportionment between the activities using a 'partial exemption method' in order to calculate how much input tax is recoverable.

HMRC’s guidance explains that as a VAT-registered business, you can recover the VAT on your purchases which relate to taxable supplies that you make or intend to make. There are some items where input tax recovery is ‘blocked’. Supplies that are made outside the UK that would be taxable if in the UK and certain exempt supplies to non-UK customers also give the right to recover VAT, but there are special rules. In principle, you cannot recover VAT that relates to any exempt supplies, although you may be able to if the VAT is below certain limits.

There are a number of partial exemption methods available. The standard method of recovering any remaining input tax is to apply the ratio of the value of taxable supplies to total supplies, subject to the exclusion of certain items which could prove distortive. The standard method is automatically overridden where it produces a result that differs substantially from one based on the actual use of inputs. It is possible to agree a special method with HMRC. The VAT incurred on exempt supplies can be recovered subject to two parallel de-minimis limits.