VAT Schemes for Limited Companies: Flat Rate vs Standard vs Cash Accounting (How to Choose)

Introduction

Choosing the right VAT scheme is one of the most important — and most misunderstood — decisions a UK limited company director makes after VAT registration. In practice, many companies default to the Standard VAT Accounting scheme simply because it is the default option, without realising that alternative schemes can simplify administration, improve cash flow, or even reduce the total VAT paid to HMRC.

At the same time, choosing the wrong VAT scheme can quietly cost a business thousands of pounds over time or create unnecessary cash-flow pressure — particularly where customer payment terms are long or expense levels are low.

VAT schemes are not one-size-fits-all. They are tools, and their effectiveness depends entirely on:

• how your business earns income,
• how much VAT you incur on costs,
• when you get paid by customers,
• how predictable your cash flow is.

This guide explains the main VAT schemes available to limited companies, how each works in practice, who they are best suited for, and how to choose the right option — both now and as your business grows.

VAT Schemes for Limited Companies

Standard VAT Accounting (Default)

The Standard VAT Accounting Scheme is the default method applied automatically when a limited company registers for VAT. If no alternative scheme is selected during registration, HMRC will place the company on this scheme by default.

Despite being the default, it is not necessarily the best option for every business — but it remains the most widely used and the most flexible.

How standard VAT accounting works

Under the Standard VAT Accounting scheme:

• you charge VAT on your sales (usually at 20%);
• you reclaim VAT on eligible business expenses;
• you report both figures on your VAT return;
• you pay the difference to HMRC (or receive a refund if input VAT exceeds output VAT).

VAT is accounted for based on invoice dates, not when cash is received or paid (unless combined with Cash Accounting).

Charging 20% VAT on taxable supplies

Most VAT-registered limited companies charge 20% VAT on standard-rated goods and services. While reduced (5%) or zero (0%) rates apply in specific sectors, 20% is the norm for most professional, commercial, and service-based businesses.

Under the standard scheme:

• VAT is charged when an invoice is issued;
• VAT becomes due to HMRC even if the customer has not yet paid.

This is an important consideration for businesses with long payment terms.

Reclaiming VAT on business expenses

One of the key strengths of the standard scheme is the ability to reclaim VAT on all eligible business expenses, subject to normal VAT rules.

This typically includes VAT on:

• professional fees (accountants, solicitors, consultants);
• office rent, utilities, and supplies;
• software licences and cloud subscriptions;
• marketing and advertising costs;
• equipment, tools, and stock.

For companies with significant VATable costs, the standard scheme often produces lower net VAT payments — and in some quarters, VAT refunds.

Quarterly VAT return process

Most limited companies using the standard scheme submit quarterly VAT returns.

Each return reports:

• output VAT — VAT charged to customers;
• input VAT — VAT paid to suppliers.

The difference between the two determines whether VAT is payable to HMRC or reclaimable.

The process is transparent and well understood, but it requires accurate bookkeeping, correct VAT coding, and timely reconciliation of invoices and expenses.

Why it’s the most common scheme

The Standard VAT Accounting scheme remains the most popular option because it is:

• straightforward in principle;
• supported by all major accounting platforms;
• flexible and compatible with other schemes;
• suitable for most business models without restrictions.

It also allows companies to reclaim VAT on all eligible costs — something not all schemes permit.

Best suited for:

The standard scheme is usually the best choice for:

• companies with significant VATable expenses;
• businesses with fluctuating cost levels;
• companies that regularly reclaim VAT;
• businesses that want maximum flexibility as they grow.

For many limited companies, particularly those with professional fees, software costs, or capital expenditure, the standard scheme provides the clearest and most financially efficient VAT outcome — provided cash flow is managed carefully.

Flat Rate Scheme for Limited Companies

The Flat Rate Scheme (FRS) is designed to simplify VAT accounting and, in certain circumstances, reduce the amount of VAT a limited company pays to HMRC. However, it is also one of the most misunderstood VAT schemes, and choosing it without careful analysis can easily result in higher VAT costs rather than savings.

What the Flat Rate Scheme is

Under the Flat Rate Scheme, VAT is calculated in a fundamentally different way compared to the standard scheme.

Instead of reclaiming VAT on most purchases, a VAT-registered limited company:

• charges customers the standard 20% VAT on invoices (or the applicable VAT rate);
• pays HMRC a fixed percentage of its gross turnover (including VAT);
• keeps the difference between the VAT charged and the flat rate paid, where the scheme is beneficial.

The flat rate percentage is set by HMRC and depends on the business sector the company operates in. The idea is that the flat rate broadly reflects typical VAT costs in that sector.

Eligibility for the Flat Rate Scheme

To join and remain in the Flat Rate Scheme:

• your turnover must be under £150,000 (excluding VAT) when you join;
• you can apply at the time of VAT registration or afterwards;
• you must apply to HMRC to join — it is not automatic.

Once in the scheme, you can usually stay until turnover exceeds £230,000 (including VAT), at which point you must leave.

How the Flat Rate Scheme works in practice

In day-to-day terms:

• You invoice customers exactly as normal, charging 20% VAT.
• You do not reclaim VAT on most business purchases.
• You calculate VAT payable by applying your flat rate percentage to your VAT-inclusive turnover.
• You pay that amount to HMRC.

Additional points to note:

• New VAT-registered businesses receive a 1% discount on their flat rate percentage for the first 12 months.
• The only VAT you can reclaim under FRS is on capital assets costing more than £2,000 (including VAT) in a single purchase.

This means the Flat Rate Scheme is generally unsuitable for businesses with regular VATable expenses.

Common flat rate percentages (examples)

Some typical flat rate percentages for limited companies include:

• Accountancy / bookkeeping: 14.5%
• Advertising: 11%
• Architect / civil engineer: 14.5%
• Business consultancy: 14%
• Computer repair: 10.5%
• Management consultancy: 14%
• Software development: 14.5%

Classification matters. Choosing the wrong business category — even unintentionally — can lead to HMRC challenges, underpaid VAT, and penalties.

Limited Cost Trader rule (critical)

The Limited Cost Trader rule is one of the most important — and most overlooked — aspects of the Flat Rate Scheme.

You are classed as a limited cost trader if:

• the cost of goods is less than 2% of turnover, or
• the cost of goods is less than £1,000 per year.

If this applies, the flat rate percentage increases to 16.5%, regardless of your sector.

For many consultants, IT contractors, and service-based companies, this rule applies automatically because their main costs are services, not goods. At 16.5%, the Flat Rate Scheme offers little or no financial advantage and can even be worse than standard VAT accounting.

This rule catches many directors by surprise after they have already joined the scheme.

When the Flat Rate Scheme is beneficial

The Flat Rate Scheme can still work well for certain limited companies, particularly those that are:

• low-expense businesses;
• service-based with genuine goods purchases;
• professional services or consultancies not caught by the limited cost trader rule;
• directors who prioritise simple record-keeping over detailed VAT tracking.

For the right business model, FRS can reduce admin and improve predictability — but it must be tested with real numbers first.

Example calculation

A consultancy invoices £100,000 + VAT during the year.

• VAT charged to clients: £20,000
• Gross turnover: £120,000

If the flat rate percentage is 14%:

• VAT paid to HMRC: £16,800
• Difference retained: £3,200

However, if the company is a limited cost trader at 16.5%:

• VAT paid to HMRC: £19,800
• Benefit reduced to £200, often less than what could be reclaimed under standard VAT.

This example shows why the Flat Rate Scheme must be modelled carefully before choosing it.

Cash Accounting Scheme

The Cash Accounting Scheme does not change how much VAT you ultimately pay, but it changes when VAT is paid and reclaimed, which can have a major impact on cash flow.

How the Cash Accounting Scheme works

Under this scheme:

• you pay VAT to HMRC only when customers pay you;
• you reclaim VAT only when you pay suppliers.

This contrasts with the standard scheme, where VAT is due based on invoice dates, regardless of whether cash has moved.

Eligibility

To use the Cash Accounting Scheme:

• your turnover must be under £1.35 million;
• most small and medium-sized limited companies qualify.

Approval is usually straightforward.

Ideal for companies with payment terms

This scheme is particularly valuable for businesses that:

• offer 30–60 day payment terms;
• regularly experience late customer payments;
• manage a large debtor book.

By aligning VAT payments with actual cash receipts, the scheme significantly reduces the risk of funding VAT out of pocket.

Managing the debtor book

One of the biggest advantages is that VAT becomes cash-neutral. You only pay VAT once the customer has paid you, which makes cash-flow forecasting far more predictable.

Bad debt protection

If a customer never pays:

• you never pay VAT on that invoice.

This is a major advantage compared to the standard scheme, where VAT may already have been paid to HMRC before the debt is written off.

Combining with other schemes

The Cash Accounting Scheme can be combined with:

• the Standard VAT Scheme;
• in some cases, the Flat Rate Scheme (subject to eligibility).

This flexibility makes it a popular choice for service-based limited companies with long payment cycles.

Application process

You can apply:

• online via HMRC, or
• through your accountant as part of VAT registration or later.

For most limited companies, approval is quick and uncomplicated.

In practice:
The Flat Rate Scheme focuses on simplicity and potential VAT savings, while the Cash Accounting Scheme focuses on cash-flow protection. Choosing between them — or deciding to stay on the standard scheme — should always be based on real numbers, not assumptions.

Annual Accounting Scheme

The Annual Accounting Scheme is designed to reduce how often a limited company has to deal with VAT reporting, making it attractive for directors who want fewer deadlines and more predictability.

Rather than focusing on VAT savings, this scheme is about administrative simplicity and cash-flow planning.

How the Annual Accounting Scheme works

Under the Annual Accounting Scheme:

• you submit one VAT return per year, instead of four quarterly returns;
• you make advance VAT payments during the year based on an estimate;
• those payments are spread evenly as either:
  • nine monthly instalments, or
  • three quarterly instalments.

At the end of the year, you submit a single VAT return that:

• confirms your actual VAT position;
• adjusts for any overpayments or underpayments.

If you’ve paid too much, HMRC refunds the difference. If you’ve paid too little, you settle the balance.

Eligibility

To use the Annual Accounting Scheme:

• your taxable turnover must be under £1.35 million;
• most small and medium-sized limited companies qualify.

You can apply:

• when registering for VAT, or
• later, once VAT registration is active.

Reduced administrative burden

One of the biggest advantages of this scheme is fewer reporting events.

Compared to quarterly VAT returns, the annual scheme:

• reduces reporting frequency by 75%;
• minimises disruption during the year;
• lowers the risk of missed deadlines.

Although VAT records must still be maintained throughout the year (especially under Making Tax Digital), many directors find the reduced filing pressure easier to manage alongside other business responsibilities.

Cash flow planning implications

Because VAT payments are agreed in advance:

• cash outflows are predictable and budgetable;
• VAT payments feel more like a regular operating cost;
• sudden large VAT bills are avoided.

This predictability is particularly useful for businesses with:

• steady income,
• long-term contracts,
• limited seasonal fluctuation.

Any difference between estimated and actual VAT is corrected in the final return, keeping the system fair and transparent.

Best suited for:

The Annual Accounting Scheme works best for:

• stable, predictable businesses;
• companies with consistent monthly turnover;
• directors who prioritise planning certainty over flexibility;
• businesses that prefer fewer compliance deadlines.

It is generally less suitable for rapidly growing companies or businesses with volatile income, where advance estimates may quickly become inaccurate.

Choosing the Right Scheme for Your Limited Company

There is no universally “best” VAT scheme. The right choice depends entirely on how your limited company operates.

What works perfectly for one business may be inefficient or expensive for another.

Decision matrix by company type

This matrix is a starting point — not a final answer.

Why financial modelling matters

Choosing a VAT scheme based on assumptions or general advice is risky. A proper comparison should model:

• VAT charged vs VAT reclaimed;
• timing of cash inflows and outflows;
• administrative effort and software costs;
• expected growth and future eligibility.

Small percentage differences can translate into thousands of pounds over time, especially once turnover increases.

Switching between VAT schemes

VAT schemes are not permanent, but switching is regulated.

Key points to understand:

• notice periods apply when changing schemes;
• frequent switching is discouraged by HMRC;
• timing matters, particularly around year-end and growth thresholds.

Switching too late often means missed savings. Switching too early can create unnecessary complexity.

Professional advice recommendation

Many VAT scheme mistakes are only discovered years later, when directors realise they have quietly overpaid VAT or created avoidable cash-flow pressure.

In practice, professional modelling before choosing a VAT scheme often pays for itself many times over — especially for service-based limited companies and consultancies.

Example scenario

Two identical consulting companies, same turnover and same clients:

• Company A chooses the Standard VAT scheme and reclaims £8,000 of VAT annually on software, professional fees, and operating costs.
• Company B chooses the Flat Rate Scheme but is classed as a Limited Cost Trader, paying 16.5% VAT and reclaiming almost nothing.

Same revenue. Same sector.
Very different VAT outcomes.

Need Help Choosing the Right VAT Scheme?

Choosing the wrong VAT scheme can quietly cost your limited company thousands of pounds over time. Choosing the right one can simplify compliance, stabilise cash flow, and support growth.

Audit Consulting Group – Accounting and Tax helps UK limited companies with:

• VAT scheme comparison and financial modelling
• Flat Rate vs Standard VAT analysis
• Cash flow optimisation
• VAT scheme changes and HMRC communication

+44 7386 212550
info@auditconsultinggroup.co.uk

We provide practical, director-level advice — not generic VAT answers.