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Compliance17 October 2026·14 min read

Flat rate VAT for contractors in 2026

The VAT Flat Rate Scheme swaps VAT reclaims for one percentage of your VAT-inclusive turnover. For a contractor whose costs are mostly services, the limited cost rule usually pushes that percentage to 16.5%. This guide covers the join and leave limits, how to run the limited cost test, the first-year discount, and a worked quarterly comparison.

For most contractors whose costs are mostly services, the VAT Flat Rate Scheme is not worth keeping beyond the first year. You pay HM Revenue and Customs (HMRC) a fixed percentage of your VAT-inclusive turnover and give up most VAT reclaims. The limited cost trader rule then sets that percentage at the rate of 16.5% if you spend very little on physical goods. The one clear gain is the 1% first-year discount. After that, run the numbers against standard VAT accounting before you decide.

What is the VAT Flat Rate Scheme, and who is it for?

The flat rate VAT scheme is an optional way to account for VAT. HMRC designed it to simplify VAT for small businesses, and its notice says it is built to simplify your records of sales and purchases. For small business owners with few purchases, that was the appeal: one calculation instead of a running tally of input VAT.

It is aimed at VAT-registered businesses with modest turnover, and it has traditionally suited contractors, consultants and other service businesses whose costs are low. That last point is now the problem. The same low costs that make the paperwork easy are what trigger the higher rate. Whether you should use the scheme depends on what you buy, not how simple it feels.

How the flat rate VAT scheme works

Under the standard VAT scheme you charge VAT on your invoices, subtract the VAT you paid on your costs, and pay HMRC the difference. The Flat Rate Scheme replaces that sum. VAT Notice 733 describes it as applying a fixed flat rate percentage to your gross turnover to arrive at the VAT due. The flat rate percentage depends on your business type.

You still charge your client VAT at the standard rate of VAT, 20%, on the invoice. Your client sees no difference. Only the amount of VAT you pay to HMRC changes, and you keep the difference between the VAT you charged and the flat rate amount you pay over.

Two terms matter from the start:

  • VAT-inclusive turnover is your business income plus the VAT charged on it. GOV.UK is clear that this is different from standard VAT turnover. The flat rate is applied to the larger, VAT-inclusive figure.
  • Flat rate turnover is the term VAT Notice 733 uses for the turnover figure the scheme works from. It includes any exempt income you have.

GOV.UK's own example: you bill £1,000 plus 20% VAT, so £1,200 in total. If your flat rate is 11%, your VAT payable is 11% of £1,200, which is £132.

VAT charged to clients, VAT paid to HMRC

To work out your VAT liability for a return, add up everything you invoiced including VAT, then multiply by your flat rate. That is the VAT payable for the period. You do not need to total the VAT on each supplier invoice to account for VAT in the usual way.

What you give up under flat rate VAT accounting

The trade-off is input tax. HMRC's notice says that if you use the scheme you do not recover input tax or VAT on your purchases. In plain terms, you cannot reclaim VAT on most of what the company buys. The exception is capital expenditure goods costing £2,000 or more including VAT, on which input tax can be claimed. HMRC's example is a van bought on hire purchase.

The £2,000 test works on items bought together. A PC, monitor and hard drive on one receipt can be combined. A £1,500 PC bought in one month and a £500 monitor bought the next cannot be added together to reach £2,000.

A few other points from VAT Notice 733:

  • You cannot use the scheme for supplies that fall under the VAT domestic reverse charge. That includes the reverse charge for building and construction services.
  • Exempt income counts towards your flat rate turnover, so you pay flat rate VAT on it.
  • You cannot use the Flat Rate Scheme together with the Cash Accounting Scheme. The scheme has its own cash-based method.
  • You must keep digital records and submit returns using software that works with Making Tax Digital for VAT.

Who can join the scheme, and the turnover limits

You must be VAT registered, or applying for VAT registration at the same time. The turnover limits are:

Limit Figure Measured
To join £150,000 or less VAT-taxable turnover, excluding VAT, expected over the next 12 months
To stay £230,000 Turnover including VAT

The £150,000 entry limit is separate from the £90,000 compulsory VAT registration threshold. You can be required to register for VAT and still be well inside the scheme.

You must leave if your VAT-inclusive turnover goes over £230,000. In practice that means any of these: your turnover over the 12 months to the anniversary of joining exceeded £230,000, you expect it to in the next 12 months, or you expect more than £230,000 in the next 30 days alone. A contractor who lands a large one-off project can trigger the third test without a big year behind them.

You cannot join the scheme if:

  • you left the scheme in the previous 12 months;
  • you committed a VAT offence in the previous 12 months;
  • you joined, or were eligible to join, a VAT group in the previous 24 months, or registered for VAT as a business division in that time;
  • your business is closely associated with another business; or
  • you have joined a margin or capital goods VAT scheme.

The scheme is voluntary. You can leave whenever you choose by writing to HMRC. After you leave, you cannot rejoin for at least 12 months. Treat leaving as a decision you make carefully, not one you reverse next quarter.

What type of flat rate percentage is right for your business type?

GOV.UK publishes a flat rate for each business type. These are the ones contractors meet most often:

Business type Flat rate
Computer and IT consultancy or data processing 14.5%
Management consultancy 14%
Architect, civil and structural engineer or surveyor 14.5%
General building or construction services 9.5%
Labour-only building or construction services 14.5%

HMRC's internal manual puts hardware and software consultants, and software publishing, in the IT consultancy sector. It places trades such as electricians, plumbers, joiners and painters under building and construction.

The building split depends on materials. GOV.UK defines labour-only building or construction services as building services where the value of materials you supply is less than 10% of the turnover for those services. At 10% or more, you use the general building rate of 9.5%.

That gap of five percentage points is large. If you are a construction subcontractor, getting the category right matters more than almost any other decision in this article. Pick the business type that matches what you actually do, because the rate you apply follows from it.

The limited cost trader category and the flat rate of 16.5%

The limited cost rule came into force on 1 April 2017. Before then, some contractors paid a rate as low as 11% on a business that spent almost nothing on goods, and kept a lot of the VAT. The limited cost trader category closed that gap.

GOV.UK calls such a business a ‘limited cost business’. It must use a flat rate of 16.5% instead of its sector rate. That is higher than every sector rate in the table above. HMRC warns in its notice that a limited cost trader may pay more VAT than on standard accounting.

How to work out whether you are a limited cost trader

HMRC's test compares what you spend on relevant goods, including VAT, with your flat rate turnover for the return period. You are a limited cost business if your spend is either:

  • less than 2% of your VAT flat rate turnover; or
  • more than 2% of it, but less than £1,000 a year.

If your return covers less than a year, the £1,000 is pro-rated. For a quarterly return it is £250. If you file annual returns, the test covers the full year.

To avoid the 16.5% rate you must pass both parts. You need to spend at least 2% and at least £1,000 a year (£250 a quarter). HMRC's three examples show how this works on a quarterly return:

  • Turnover of £10,000 and relevant goods of £260. That is above 2% (£200) and above £250, so the sector rate applies.
  • Turnover of £20,000 and relevant goods of £325. That is above £250 but below 2% (£400), so 16.5% applies.
  • Turnover of £10,000 and relevant goods of £225. That is above 2% (£200) but below £250, so 16.5% applies.

HMRC says businesses close to the 2% line may need to run the test on every VAT return. You can pay the sector rate in one period and 16.5% in the next, depending on what you bought.

What counts as relevant goods

This is where most contractors lose the argument. The test separates goods and services, and only goods count. They must also be used exclusively for the purposes of your business, and many purchases are excluded or are not goods at all.

What HMRC's notice says does not count:

  • Services. Accountancy fees, advertising, rent, postage and stamps, and anything leased or hired to the business are services. So is software you download, and bespoke software even if it is not supplied electronically.
  • Capital expenditure. A laptop or mobile phone for business use is excluded as capital expenditure.
  • Food and drink for you or your staff.
  • Fuel for a car, unless you work in the transport sector using your own or a leased vehicle.
  • Goods not used only for the business, such as electricity supplying both a home and a home office.
  • Goods bought only to pass the test. Stockpiled or thrown-away quantities do not count.

What does count includes goods provided by a subcontractor and itemised separately, and goods bought without VAT being charged (if not otherwise excluded). HMRC says its list is not exhaustive.

The result for a typical consultant or IT contractor is plain. Most of your spend is accountancy, insurance, software and travel, none of which is goods. Your laptop does not count towards the test, and you cannot reclaim VAT on it unless it costs £2,000 or more including VAT. Many service contractors will land on the flat rate of 16.5% and stay there.

HMRC also provides a calculator on GOV.UK to check whether you are a limited cost business. You will need your relevant turnover and your spend on relevant goods for the most recent return period.

The 1% first-year discount

If you are in your first year as a VAT-registered business, you can take 1% off your flat rate until the day before your first anniversary of becoming VAT registered.

Three details catch people out:

  • The 12 months run from the date you registered for VAT, not the date you joined the scheme. If you register in January and join in July, you have lost six months of discount.
  • The discount applies to the limited cost rate too. HMRC's own example is a limited cost business that registers on 1 April 2017: it pays 15.5% from that date to 31 March 2018.
  • You lose the entitlement if you register for VAT 12 months after you were required to.

In practice, a service contractor in the first year pays 13.5% on IT consultancy if they pass the goods test, or 15.5% if they do not.

A worked example: standard VAT against the flat rate

These figures are illustrative. Take an IT contractor with a limited company, on quarterly returns:

  • Invoices of £20,000 plus £4,000 VAT, so VAT-inclusive turnover is £24,000.
  • Total input VAT across all costs (accountant, software, insurance, travel, equipment) of £250 for the quarter.
  • The 2% line is £480 (2% of £24,000). The quarterly floor is £250. So relevant goods must be more than £480 including VAT to avoid the 16.5% rate.
Method Calculation VAT paid to HMRC
Standard VAT £4,000 output less £250 input £3,750
Flat rate, limited cost (goods £300) 16.5% of £24,000 £3,960
Flat rate, limited cost, first year 15.5% of £24,000 £3,720
Flat rate, sector rate (goods £600) 14.5% of £24,000 £3,480
Flat rate, sector rate, first year 13.5% of £24,000 £3,240

On these assumptions, the limited cost trader pays £210 more per quarter than on standard VAT. In the first year the same contractor is £30 better off on the flat rate. The contractor who spends £600 on relevant goods instead of £300 pays £480 less to HMRC for that quarter, because crossing the 2% line removes 2 percentage points of the rate.

The example shows two things. First, the limited cost rule turns on a narrow band of spending, so a single quarter's purchases can move the result. Second, the comparison that matters is the flat rate against standard VAT after reclaiming your actual input VAT, not against the VAT you charged. Replace the £250 with your own figure before relying on any of this.

Standard VAT or flat rate: should I be using the scheme?

The benefits of the flat rate scheme are real but narrower than they were. The Flat Rate Scheme can still make sense in these situations:

  • Your first year of VAT registration. The 1% discount can tip a marginal comparison your way, even at 16.5%.
  • You pass the goods test and your sector rate is low. A contractor in general building at 9.5%, with sizeable materials spend, is in a different position from an IT consultant.
  • You value the simpler return and your reclaimable costs are small. You do not have to track input VAT on routine purchases.

It is usually a poor fit when:

  • you are a limited cost business and pay 16.5% on all your VAT-inclusive turnover;
  • you have significant reclaimable costs, particularly if they are goods or equipment;
  • you have zero-rated or exempt sales, because flat rate VAT is still charged on that turnover;
  • your turnover is close to £230,000 including VAT and you may need to leave soon anyway; or
  • you expect costs to vary a lot across the year.

The simplicity argument is weaker than it was. With bookkeeping software, recording input VAT is largely automatic, and the scheme saves less admin than it used to. Compare your numbers under both methods for a recent quarter, and again once your first year ends. If you stay on the scheme, set a reminder to re-run the limited cost test at the end of each return period.

How to register for the VAT Flat Rate Scheme

You must be VAT registered, or register at the same time. You can apply online through your HMRC Government Gateway account, or by post using form VAT600FRS. If you want to join the Flat Rate Scheme and the Annual Accounting Scheme together, there is a combined form, VAT600AA/FRS. When you apply you give details of your business activity so HMRC can assign the correct flat rate, and you state your expected VAT-taxable turnover for the next 12 months, which must be £150,000 or less excluding VAT. HMRC then confirms your start date and flat rate percentage.

To leave, write to HMRC. Remember the 12-month wait before you can rejoin.

Frequently Asked Questions

What is the VAT flat rate scheme? It is an HMRC scheme where you pay a fixed percentage of your VAT-inclusive turnover to HMRC, instead of working out the difference between output VAT and input VAT.

Can I reclaim VAT on purchases under the Flat Rate Scheme? Not on most purchases. The exception is capital expenditure goods costing £2,000 or more including VAT, bought as a single item or on a single receipt.

Is a laptop a relevant good for the limited cost test? No. HMRC treats a laptop or mobile phone for business use as capital expenditure, and capital expenditure is excluded from the test.

Does the 1% discount apply if I am a limited cost trader? Yes. HMRC's own example shows a limited cost business using 15.5% in its first year of VAT registration.

What happens if my turnover goes over £230,000? You must leave the scheme and move to standard VAT accounting. You then cannot rejoin for at least 12 months.

Do I need to tell my client I am on the scheme? No. You charge VAT at the standard rate on your invoices. The flat rate changes only what you pay to HMRC.

Where Deplexify fits

Deplexify's contractor service is £75 a month for a limited company. VAT returns are an optional add-on at £15 a month, prepared as Making Tax Digital returns under either standard VAT or the flat rate scheme.

Sources

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