Flat rate, cash accounting or neither: choosing a VAT scheme

For years the Flat Rate Scheme was the standard advice for a small building firm. On 1 March 2021 that advice quietly expired for anyone who subcontracts, and a great many firms are still on a scheme that no longer fits the work they do.

VAT Notice 733 says it in one line: "You cannot use the VAT Flat Rate Scheme for supplies of goods and services that are subject to one of the VAT domestic reverse charges."

That is not a warning about efficiency. It is a prohibition, and the construction domestic reverse charge covers most subcontract work billed to a VAT-registered contractor. What exactly counts as a reverse charge supply, and the four questions that decide it, are in when your invoice must not show VAT.

This article works through the four ways a trade business can account for VAT and says which survives which kind of work.

Before the schemes: are you in at all

The registration threshold is taxable turnover over the last twelve months exceeding £90,000, or an expectation of exceeding it in the next 30 days. GOV.UK sets the mechanics precisely: "You have to register within 30 days of the end of the month when you went over the threshold", and "Your effective date of registration is the first day of the second month after you go over the threshold."

The rolling twelve months is not your accounting year. It is any twelve consecutive months, checked at the end of every month.

The deregistration threshold is £88,000: if taxable turnover falls below it, you can ask HMRC to cancel the registration. The £2,000 gap between the two figures is deliberate — it stops a business at the line registering and deregistering on alternate years.

Voluntary registration is worth a hard look in construction, and the reason is specific to the trade rather than general. If your work is zero-rated — new-build housing being the common case — you charge no VAT out and reclaim VAT on materials in. That is a repayment position, not a cost.

Standard VAT accounting

The default. You account for VAT by reference to the tax point, which for services is generally when the services are performed, subject to the 14-day invoicing rule and to any earlier invoice or payment. You reclaim input tax on your purchases. You file quarterly, or monthly if you ask.

Its one real drawback for a trade business is that output tax is due on invoices your customer has not paid. You bill £24,000 including £4,000 of VAT in March, get paid in July, and the £4,000 was due to HMRC in May. That is the problem the Cash Accounting Scheme exists to solve.

Its advantage is that it is the only method with no scheme rules to fall out of and no interaction to get wrong. If your work is a mix of reverse charge and non-reverse charge, standard accounting handles both without a special case.

The Flat Rate Scheme

The idea is simplification: instead of adding up input tax, you pay a fixed percentage of your gross turnover and keep the difference.

Limits. You may join if your taxable turnover excluding VAT in the next year will be £150,000 or less. You must leave when "total value of your income for the year then ending (excluding sales of capital assets) is more than £230,000".

The construction percentages.

The line between them is a definition, not a judgement: "'Labour-only building or construction services' means building services where the value of the materials supplied is less than 10% of the turnover for those services." That is a different labour/materials split from the one the CIS deduction runs on, and the two are worth not confusing: see the Construction Industry Scheme: 20, 30 or nothing.

Ten per cent is a low bar. A joiner who buys the timber is comfortably in the 9.5 per cent category. A plasterer who works on the main contractor's materials is at 14.5 per cent.

The 1 per cent discount. A newly VAT-registered business gets a 1 percentage point reduction in its flat rate for the first twelve months.

The limited cost trap. Since 1 April 2017 there is a rate that overrides the trade sector entirely. You are a limited cost business, and pay 16.5 per cent, if your spending on relevant goods is either

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

Relevant goods are goods, not services, and the exclusions matter: capital items, goods bought for resale, food for employees, and vehicle fuel outside the transport sector are all excluded.

16.5 per cent of a VAT-inclusive turnover is very close to 20 per cent of the net — which is the point. For a labour-only trade with almost no material purchases, the Flat Rate Scheme now offers no gain at all, and the paperwork of proving you are not a limited cost business each quarter is a real cost.

And then the prohibition. You cannot use the scheme for supplies subject to a domestic reverse charge. HMRC's reverse charge technical guide spells out the mechanics: "Reverse charge supplies are not to be accounted for under the scheme", and a business making them should exclude those values from its flat rate calculation.

For a subcontractor whose work is mostly reverse-charge, that removes most of the turnover from the scheme and leaves the awkward remainder inside it — a fixed percentage applied to a shrunken base, with the exclusion to be worked out every quarter. The simplification the scheme was chosen for has gone.

Who the Flat Rate Scheme still suits in construction: a firm working directly for householders, on standard-rated work, with material purchases comfortably over 2 per cent of turnover and over £1,000 a year. That is a real business — a domestic bathroom or kitchen fitter, for instance — and for them the scheme is unchanged.

Who it no longer suits: almost every subcontractor.

The Cash Accounting Scheme

You account for VAT when money moves, not when invoices are issued. Output tax is due when the customer pays; input tax is reclaimed when you pay your supplier.

Limits. You may join if you expect the value of your taxable supplies in the next year to be £1.35 million or less. You must leave when the value of your taxable supplies, including disposals of stock and capital assets but excluding VAT, goes over £1.6 million.

What it cannot cover. Goods bought or sold under lease purchase, hire purchase, conditional sale or credit sale agreements; and goods imported or acquired from an EU member state.

Its great strength is bad debt and slow payment. Under cash accounting an unpaid invoice never produces a VAT liability, because there is nothing to account for until the money arrives. On construction payment terms — where 45 and 60 days are ordinary and retention runs longer — that is not a marginal benefit.

Under the reverse charge it is barred too — and pointless besides. HMRC's reverse charge technical guide states: "You cannot use the VAT Cash Accounting Scheme for supplies or services you buy or sell that are subject to the reverse charge." The scheme can continue for your other transactions.

Notice 731 then adds why the remainder is not worth having: where "most of your sales are covered by the VAT domestic reverse charge, using the Cash Accounting Scheme may not benefit you. This is because if you use the scheme, you have to wait until you've paid for a supply before you can claim back the VAT as input tax."

Follow the logic. A reverse-charge subcontractor has almost no output tax to defer, because they charge none. What cash accounting then does is delay the reclaim on their own purchases until they have paid for them. The scheme's only remaining effect is negative.

For a main contractor billing end users, the position is the opposite: substantial output tax on slow-paying invoices, which is exactly what the scheme is for.

The Annual Accounting Scheme

One VAT return a year, with payments on account through the year.

Limits. Join if estimated VAT taxable turnover is £1.35 million or less in the next twelve months; leave when it is, or is likely to be, more than £1.6 million at the end of the annual accounting year.

How the payments work. For an accounting period of four to twelve months, either nine monthly instalments of 10 per cent of the estimated bill, in months 4 to 12, or three quarterly instalments of 25 per cent, in months 4, 7 and 10. The return and the balancing payment are due two months after the end of the accounting period.

The trade-off is honest and simple: fewer filings, less flexibility. If you are in a repayment position — and reverse-charge subcontractors usually are — waiting a year for a refund is the wrong direction of travel entirely. Monthly returns are the right answer for a repayment trader, not annual ones.

Which scheme fits which business

Two things every scheme shares

Making Tax Digital applies regardless. Every VAT-registered business has been inside MTD for VAT since 1 April 2022 whatever its turnover, and no scheme is an exception. Which scheme you use is part of the designatory data the electronic account has to hold.

Changing scheme is a date, not a mood. Each scheme has its own rules on when you may join and when you must leave, and leaving late is a compliance failure rather than an oversight. Diarise the exit thresholds — £230,000 for flat rate, £1.6 million for cash and annual accounting — as monthly checks, not as year-end questions.

A short checklist

1. Work out what proportion of your turnover is reverse-charge work. That one number decides more than any other here.
2. If you are on the Flat Rate Scheme and subcontract, check today whether you are applying it to supplies the notice prohibits. This is not an optimisation question.
3. Test yourself against the limited cost rule before assuming your sector percentage applies: relevant goods under 2 per cent of flat rate turnover, or under £1,000 a year, and you are at 16.5 per cent.
4. If you are consistently in repayment, ask for monthly returns. Waiting three months for money you are owed is a choice.
5. Check your rolling twelve-month turnover at the end of every month, not at the year end. The registration test is rolling.

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Position as at 29 August 2026. This article describes the law and is not tax advice. Scheme thresholds and flat rate percentages are set by HMRC and change; the sources below carry the dates on which they were checked. Which scheme is right depends on figures specific to your business.

What Zirko does here: an invoice can be issued with or without VAT and with a fixed reverse charge note, and materials and labour stay as separate lines, so the split between reverse-charge and ordinary turnover is visible rather than estimated. Zirko does not choose a VAT scheme for you, does not calculate a flat rate liability and does not submit VAT returns.