VAT accounting schemes compared

Without a scheme, a VAT-registered business normally accounts for VAT on the invoices it issues and receives, and files four returns a year. The schemes below change one part of that picture.

Under cash accounting you pay VAT on your sales when your customers pay you, and reclaim VAT on purchases once you have paid your supplier. The obvious benefit is cash flow for a business whose customers pay slowly, because you are not handing HMRC VAT you have not yet received. The flip side is that VAT on purchases is also delayed until you pay for them.

You do not need to apply. GOV.UK says you join at the beginning of a VAT accounting period, as long as you are eligible, and you cannot use it if you are on the Flat Rate Scheme, are not up to date with your returns or payments, or have committed a VAT offence in the last 12 months. You must leave if your VAT taxable turnover is more than £1.6 million. On leaving, you have to report and pay any outstanding VAT, including on invoices customers have not yet paid, though you can usually spread this over 6 months.

Annual accounting replaces four returns with one. You make advance payments through the year, based on your last return or an estimate if you are new to VAT, then submit a single return and either make a balancing payment or claim a refund.

GOV.UK says the advances are either nine monthly payments of 10% of your estimated bill, at the end of months 4 to 12, or three quarterly payments of 25%, at the end of months 4, 7 and 10. The return is due 2 months after the end of your accounting period, and the balancing payment within 2 months of month 12. GOV.UK warns that the scheme would not suit a business that regularly reclaims VAT, since repayments come once a year. You cannot join if you left in the last 12 months, are part of a VAT group or division, are behind with returns or payments, or are insolvent.

The Flat Rate Scheme swaps the normal calculation for a fixed percentage of your VAT inclusive turnover, set by your type of business, and in return you generally cannot reclaim VAT on purchases. Businesses that spend very little on goods pay 16.5%. It is the scheme most often discussed by freelancers and contractors, and our separate guide to the VAT flat rate scheme covers the rates and the limited cost business test in detail.

Retail schemes give businesses that sell goods a simpler way to calculate how much VAT to record, and GOV.UK describes three standard schemes. Point of sale suits businesses that can identify the VAT rate when each sale is made, for example through an electronic till. Apportionment is only for businesses that buy goods for resale, and direct calculation suits those making a small proportion of sales at one rate and most at another. The apportionment and direct calculation schemes have a version for turnover up to £1 million and another for turnover between £1 million and £130 million, and above £130 million a bespoke scheme must be agreed with HMRC.

Margin schemes let dealers in second-hand goods, works of art, and antiques and collectors' items account for VAT on the difference between what they paid for an item and what they sold it for, instead of the full selling price. Business overheads, repairs, and parts or accessories cannot be included in the margin calculation and are reclaimed in the normal way.

GOV.UK sets some firm rules. You cannot use cash accounting if you are on the Flat Rate Scheme, and you cannot use retail schemes with the Flat Rate Scheme. You also cannot join the Flat Rate Scheme if you have joined a margin or capital goods scheme. Annual accounting can be used alongside the Flat Rate Scheme, but needs its own separate application.

Whichever you use, returns still go through software that works with Making Tax Digital for VAT, and our guide to VAT deadlines and penalties explains what happens if a return or payment is late. If you are not yet registered, start with how to register for VAT, since some schemes are easiest to join at the same time.

This is general information, not tax advice. The VAT returns service page explains how accountants help, and if you would like help choosing, we read every enquiry and, where we can, will put you in touch with a local accountant through our enquiry form.