If you run a small business and you're VAT-registered, you've probably wondered whether the Flat Rate Scheme is the easy win it once seemed. For a lot of businesses, it isn't any more.
The scheme still does what it always did: it simplifies your VAT and, in the right circumstances, leaves a little extra in your pocket. But a rule called the limited cost trader test now pushes most low-spend service businesses onto a 16.5% flat rate, and at that rate the maths often turns against you.
This guide explains how the scheme works in 2026, who it still suits, where the traps are, and how to decide using your own numbers rather than a rule of thumb. It's written for sole traders, contractors and small limited companies weighing up their options.
What is the VAT Flat Rate Scheme?
Under normal VAT accounting, you charge VAT on your sales, reclaim VAT on your costs, and pay HMRC the difference. The Flat Rate Scheme replaces that with a single sum: you still charge your customers the standard 20% rate of VAT, but you hand HMRC a fixed percentage of your gross (VAT-inclusive) turnover instead.
The trade-off is simple. You keep the difference between the 20% you collect and the flat rate you pay over, but in return you usually can't reclaim the VAT on your purchases. There's one exception: VAT on certain single capital asset purchases costing £2,000 or more (including VAT) can still be reclaimed.
The flat rate percentage depends on your trade sector. HMRC publishes a table of rates, and they vary a lot. Here are a few examples for 2025/26.
| Business sector | Flat rate |
|---|---|
| Accountancy or book-keeping | 14.5% |
| Computer and IT consultancy or data processing | 14.5% |
| Advertising | 11% |
| Photography | 11% |
| General building or construction (labour only) | 14.5% |
| Catering services (including takeaway) | 12.5% |
| Hotel or accommodation | 10.5% |
| Retailing food, confectionery, newspapers | 4% |
There's also a sweetener for new registrations: you get a 1% discount on your flat rate for your first year as a VAT-registered business. So an advertising business on 11% pays 10% in year one.
You can read HMRC's full sector list and the scheme rules in VAT Notice 733.
Who can join the Flat Rate Scheme?
You can apply to join if your VAT taxable turnover (excluding VAT) is expected to be £150,000 or less in the next 12 months. That's separate from the VAT registration threshold itself, which is £90,000 of taxable turnover for 2025/26.
You have to leave the scheme once you grow past it. You must come off the Flat Rate Scheme if, on the anniversary of joining, your total business income including VAT for the year then ending is more than £230,000, or if you've reasonable grounds to expect your income in the next 30 days alone to exceed £230,000. The £150,000 limit is the door in; the £230,000 limit is the door out.
If you leave, you normally have to wait 12 months before you can rejoin.
What is the limited cost trader rule?
This is the rule that changed everything, and it's the reason so many businesses have quietly left the scheme.
Since 1 April 2017, if your business spends very little on goods, you're classed as a "limited cost business" (often called a limited cost trader) and you must use a flat rate of 16.5%, no matter what your sector rate would otherwise be.
You're a limited cost business in any VAT period if the cost of your "relevant goods" is either:
- less than 2% of your VAT-inclusive flat rate turnover, or
- more than 2% but less than £1,000 a year (about £250 a quarter).
The sting is in the definition of relevant goods. Goods means physical items used exclusively for your business. It specifically excludes:
- capital expenditure (equipment, computers, furniture and the like)
- food and drink for you or your staff
- vehicles, vehicle parts and fuel (unless you're in a transport business using your own vehicles)
- goods bought to resell or hire out, unless that's your main trade
- any services at all.
That last point is the killer for most modern service businesses. Software subscriptions, rent, accountancy fees, phone and broadband, advertising and training are all services, so none of them count towards the 2% test. A contractor or consultant who works from a laptop and buys almost no physical stock will nearly always be a limited cost trader, and 16.5% is close to the full 20% you collected.
You have to apply this test every VAT period, so your status can flip from one quarter to the next if your goods spending moves around the threshold. HMRC provides a limited cost business checker within Notice 733.
Illustrative example: when the scheme costs you money
Illustrative example. Priya is an IT consultant trading through a limited company. She buys almost no physical goods, so she's a limited cost trader and must use the 16.5% rate. In a year she invoices £80,000 plus VAT.
- Net sales: £80,000
- VAT charged at 20%: £16,000
- Gross (VAT-inclusive) turnover: £96,000
On the Flat Rate Scheme at 16.5%, she pays HMRC 16.5% of £96,000, which is £15,840. She can't reclaim input VAT, so the £15,840 is what she keeps out of the equation.
Now compare standard VAT accounting. She still collects £16,000 of VAT, but she reclaims the VAT on her costs. Say her reclaimable input VAT comes to £900 across the year (software is excluded from the goods test but the VAT on it is still reclaimable under standard accounting). She'd pay HMRC £16,000 minus £900, which is £15,100.
So in this case the Flat Rate Scheme costs her £15,840 against £15,100, around £740 a year worse off, before you even count the lost reclaim on a new laptop or other one-off purchases. For a low-cost service business, the scheme is rarely the cheaper option in 2026.
Illustrative example: when the scheme still pays
Illustrative example. Tom runs a small advertising business with a sector flat rate of 11%. He buys a reasonable amount of physical print stock and promotional goods, so he passes the goods test and is not a limited cost trader. In his first year of VAT registration he invoices £60,000 plus VAT.
- Net sales: £60,000
- VAT charged at 20%: £12,000
- Gross (VAT-inclusive) turnover: £72,000
His flat rate is 11%, less the 1% first-year discount, so 10%. He pays HMRC 10% of £72,000, which is £7,200.
Under standard accounting he'd collect £12,000 and reclaim, say, £1,500 of input VAT, paying HMRC £10,500.
Here the Flat Rate Scheme leaves £7,200 going to HMRC against £10,500, so Tom is better off by around £3,300 in year one (and roughly £2,580 once the 1% discount ends and he's on 11%). A business with a favourable sector rate, modest reclaimable costs and genuine spending on goods can still come out ahead.
So is the VAT Flat Rate Scheme still worth it in 2026?
It depends, and the honest answer is that it's worth it for fewer businesses than it used to be.
The scheme still makes sense for some. If your sector rate is genuinely favourable, you spend enough on physical goods to stay out of the limited cost trader bracket, and your reclaimable VAT is modest, you can keep a useful margin and simplify your bookkeeping at the same time.
It rarely makes sense if you're a low-cost service business forced onto 16.5%, if you make significant zero-rated or exempt sales (you'd still apply the flat rate to that income), or if you regularly buy expensive equipment whose VAT you'd want to reclaim in full.
There's no convenience prize here. The decision should come down to a side-by-side calculation of what you'd pay HMRC each way, repeated when your circumstances change.
How do you decide? A quick checklist
Work through these in order:
- Estimate your gross turnover. Net sales plus the 20% VAT you'll charge.
- Find your sector rate in HMRC's VAT Notice 733 and knock off 1% if you're in your first VAT year.
- Run the limited cost trader test. Are your relevant goods less than 2% of gross turnover, or under £1,000 a year? If so, your rate is 16.5% regardless of sector.
- Calculate the flat rate cost: flat rate percentage times gross turnover.
- Calculate the standard cost: VAT charged minus the input VAT you could reclaim.
- Compare the two, and remember to factor in any big one-off purchases you'd lose the reclaim on.
If the numbers are close, the simplicity of the flat rate scheme can tip the balance. If they're not, follow the cheaper option. We help limited companies, contractors and sole traders run exactly this comparison every year, because the right answer genuinely changes as a business grows and its costs shift.
Getting your underlying figures right is half the battle, which is where tidy bookkeeping and a bit of tax advice pay for themselves.
Not sure which VAT method leaves you better off? Book a free 20-minute call with a Zmartly accountant and we'll run the Flat Rate versus standard comparison on your actual numbers. Talk to a Zmartly accountant.
Frequently asked questions
What turnover can I have to join the VAT Flat Rate Scheme?
You can join if your VAT taxable turnover excluding VAT is expected to be £150,000 or less in the next 12 months. You must leave the scheme once your total income including VAT exceeds £230,000 on your joining anniversary, or if you expect to exceed £230,000 in the next 30 days.
What is the 16.5% flat rate?
The 16.5% rate applies to "limited cost businesses". You're a limited cost business in a VAT period if your spending on relevant goods is less than 2% of your VAT-inclusive turnover, or more than 2% but less than £1,000 a year. Services, capital equipment, food, drink and most vehicle costs don't count as relevant goods, so many low-cost service businesses fall into this bracket.
Can I reclaim VAT on the Flat Rate Scheme?
Generally no. You give up the right to reclaim VAT on most purchases in exchange for paying a fixed flat rate. The main exception is VAT on a single capital asset purchase costing £2,000 or more including VAT, which you can still reclaim.
Is there a discount for new businesses?
Yes. You get a 1% reduction on your flat rate for your first year as a VAT-registered business. So a sector rate of 12% becomes 11% for the first 12 months.
Is the Flat Rate Scheme still worth it for contractors in 2026?
Often not. Most contractors and consultants buy very little in the way of physical goods, so they're classed as limited cost traders and pay 16.5%. At that rate the scheme usually costs more than standard VAT accounting once you account for the input VAT you can no longer reclaim. It's worth running the comparison rather than assuming.
