Introduction – VAT guide
VAT (Value Added Tax) is a tax that businesses collect from customers on behalf of HMRC. If you’re a VAT-registered business, you need to submit VAT returns regularly. But did you know there are different ways to account for VAT? The two main VAT accounting methods are cash basis and accrual (invoice) basis, with an additional option called the Flat Rate Scheme.
Each method has advantages and limitations, and you can’t switch freely between them without meeting certain conditions. This guide will explain the basics so you can understand the best option for your business.
The Two Main VAT Accounting Methods
1. Cash Accounting for VAT
The cash basis method means you only pay VAT to HMRC when you actually receive payments from customers. Likewise, you can only reclaim VAT on purchases once you’ve paid your suppliers.
Best for:
- Small businesses with irregular cash flow.
- Businesses that experience late payments from customers.
Pros: ✅ Helps with cash flow as you only pay VAT when money is received. ✅ No VAT to pay on unpaid invoices.
Cons: ❌ Can’t reclaim VAT on unpaid purchases. ❌ Not available for businesses with taxable turnover over £1.35 million.
2. Accrual (Invoice) Accounting for VAT
Also called the standard VAT scheme, this method means you account for VAT when an invoice is issued or received, regardless of when the payment is made.
Best for:
- Businesses with regular cash flow.
- Companies that don’t experience many late payments.
Pros: ✅ Can reclaim VAT on purchases even if unpaid. ✅ Required for businesses over the £1.35 million turnover threshold.
Cons: ❌ Must pay VAT to HMRC even if customers haven’t paid you yet. ❌ Can be difficult for businesses with long payment terms.
The Flat Rate Scheme (FRS)
The Flat Rate Scheme (FRS) is a simplified VAT scheme where businesses pay a fixed percentage of their turnover instead of calculating VAT on every transaction.
Best for:
- Small businesses with taxable turnover under £150,000.
- Companies that don’t reclaim much VAT on expenses.
Pros: ✅ Simplifies VAT returns (no need to track VAT on purchases). ✅ Can be financially beneficial if you have few VAT-claimable expenses. ✅ First-year discount: pay 1% less in the first 12 months.
Cons: ❌ You may pay more VAT overall if you have lots of expenses with VAT to reclaim. ❌ You can’t reclaim VAT on most purchases, except for capital assets over £2,000.
VAT Accounting Methods Comparison Table
| Feature | Cash Basis | Accrual Basis | Flat Rate Scheme |
|---|---|---|---|
| When VAT is Paid | When payment is received | When invoice is issued | Fixed % of turnover |
| When VAT is Reclaimed | When payment is made | When invoice is received | Only on capital assets over £2,000 |
| Best For | Businesses with irregular cash flow | Businesses with steady cash flow | Small businesses with low VAT reclaimable expenses |
| Turnover Limits | Up to £1.35 million | No limit | Up to £150,000 to join, exit at £230,000 |
| VAT Reporting Complexity | Moderate | High | Low |
| Risk of Paying VAT on Unpaid Invoices | No | Yes | No |
| Eligible for VAT Reclaim on Expenses | Yes | Yes | Limited |
Can You Switch VAT Schemes?
You can’t just switch between VAT schemes whenever you like.
- Cash to Accrual (or vice versa): You need to apply to HMRC and ensure your accounts are adjusted correctly.
- Flat Rate Scheme: You must leave the scheme if your turnover exceeds £230,000.
- Rejoining a scheme: If you leave the Flat Rate Scheme, you must wait 12 months before rejoining.
Which VAT Scheme is Right for You?
- If you have irregular cash flow → Cash Accounting.
- If you want to reclaim VAT on unpaid invoices → Accrual Accounting.
- If you want simplicity and meet the requirements → Flat Rate Scheme.
Need help choosing? Speak to an accountant to find the best option for your business!
FAQs
1. What is VAT accounting?
VAT accounting is how businesses record and report VAT collected from customers and VAT paid on purchases.
2. Which VAT method is best for small businesses?
The cash basis is best for small businesses with irregular cash flow, while the Flat Rate Scheme is great for those wanting simplicity.
3. Can I switch VAT accounting methods?
Yes, but you must meet certain conditions and notify HMRC before switching.
4. Do I have to register for VAT?
You must register if your turnover exceeds £90,000 (2024 threshold). Below this, registration is voluntary.
5. How often do I submit VAT returns?
Most businesses submit VAT returns quarterly, though some opt for monthly or annual submissions.
6. Can I reclaim VAT on expenses in the Flat Rate Scheme?
Generally, no, except for capital assets costing over £2,000.
7. What happens if my turnover exceeds Flat Rate Scheme limits?
If your turnover exceeds £230,000, you must leave the scheme and switch to standard VAT accounting.
8. What is Making Tax Digital (MTD) for VAT?
MTD requires VAT-registered businesses to keep digital records and submit VAT returns using compatible software.
9. How do I pay VAT to HMRC?
You can pay VAT via direct debit, bank transfer, or online through HMRC’s portal.
10. Do I need an accountant for VAT returns?
While you can do it yourself, an accountant ensures accuracy, saves time, and helps minimise VAT liabilities.
Conclusion
Understanding cash basis, accrual basis, and the Flat Rate Scheme helps businesses choose the best VAT accounting method. If you’re unsure, consult an accountant to ensure compliance and efficiency in managing VAT.
Need more advice? Get in touch with a professional today!
