The Flat Rate Scheme for pubs, restaurants and hotels

How the scheme works

Under the Flat Rate Scheme a VAT-registered business charges VAT to customers in the normal way, then pays HMRC a fixed percentage of its VAT-inclusive turnover. It does not reclaim VAT on purchases, apart from certain capital assets. The percentage depends on the type of business.

Turnover is worked out in one of two ways. Under the basic method it is the value of sales invoiced or taken in the period. Under the cash-based method it is the VAT-inclusive sales paid for in the period, with a card payment counted on the date of the sales voucher. Bank interest and sales of capital goods on which VAT was reclaimed are left out.

The scheme saves bookkeeping, because input VAT is not tracked invoice by invoice. Whether it saves money depends on the mix of sales and purchases, and for hospitality the answer differs from one business to the next.

Flat Rate Scheme percentages for hospitality

• Limited cost business, any sector16.5%
• Catering, including restaurants and takeaways12.5%
• Hotel or accommodation10.5%
• Pubs6.5%

Who can join and when you must leave

A business can join if it expects its VAT taxable turnover in the next 12 months to be £150,000 or less, excluding VAT. It cannot join if:

• it left the scheme in the last 12 months
• it committed a VAT offence in the last 12 months
• it joined or was eligible to join a VAT group in the last 24 months
• it is closely associated with another business
• it uses a margin scheme or the capital goods scheme

The scheme cannot be used with the Cash Accounting Scheme or a retail scheme. It has its own cash-based and retail-based methods of working out turnover.

A business must leave if, on the anniversary of joining, its turnover in the last 12 months was more than £230,000 including VAT or it expects that in the next 12 months, or if it expects turnover in the next 30 days alone to be more than £230,000. It can stay if HMRC is satisfied turnover in the next 12 months will be £191,500 or less. A business that leaves cannot rejoin for 12 months.

Leaving the scheme

A business can leave at any time by writing to HMRC, which confirms the date in writing. A business that leaves part way through a VAT period works out that return in two parts: the flat rate up to the date it left, and normal VAT accounting for the rest. Turnover is checked against the £230,000 limit on each anniversary of joining, and a growing business checks at least monthly against the 30-day rule. Where HMRC finds a business was never eligible, it can backdate the withdrawal to the date the business joined.

In the first year of VAT registration the percentage is 1% lower. A café on 12.5% pays 11.5% until the day before the first anniversary of registration. The reduction does not apply to a business that registers for VAT 12 months or more after it should have.

The hospitality rates and choosing a sector

HMRC's manual, FRS7300, sets out which trades fall into each sector:

• Catering services including restaurants and takeaways, 12.5%: canteens, restaurants and cafés whether licensed or not, sandwich shops, takeaway shops and mobile food stands.
• Hotel or accommodation, 10.5%: bed and breakfasts, camping and caravan sites, holiday centres, hotels and motels with or without a restaurant, self-catering accommodation and youth hostels.
• Pubs, 6.5%: licensed clubs and "public houses however managed".

A business that does more than one of these picks the sector for its main activity, measured by turnover. A pub that takes more from food than drink may belong in catering. The choice is checked each year on the anniversary of joining. If the balance between parts of the business shifts during the year, the business keeps its percentage until then, and reviews it as at the first day of the VAT period in which the anniversary falls. HMRC says it will not change a reasonable choice retrospectively, so a note of the turnover split behind the choice is worth keeping with the VAT records.

The limited cost business test

A business is a limited cost business if its spending on relevant goods, including VAT, is less than 2% of its flat rate turnover, or more than 2% but less than £1,000 a year (£250 a quarter). It must then use 16.5% whatever its sector. HMRC says a business close to 2% may need to complete the test each time it completes a VAT return, moving between 16.5% and its sector rate as costs go above and below 2%.

Relevant goods are goods used only for the business. For a restaurant they include food bought to make customers' meals, and gas and electricity used only for the business. They do not include food and drink for staff, capital goods, services such as rent, accountancy and advertising, or goods for resale where selling them is not the main business. Most restaurants, cafés and pubs spend more than 2% of turnover on food and drink and pass the test. A small self-catering or accommodation business with few purchases of goods may not.

Zero-rated and exempt sales

Flat rate turnover includes all sales, including zero-rated and exempt ones. VAT Notice 733 gives rent as an example of exempt income that goes into it. A café that sells cold food to take away pays the flat rate on those zero-rated sales as well, which normal VAT accounting would charge at nothing.

A café selling much of its food cold to take away

Normal VAT accounting

£84,000 of standard-rated sales including VAT carry £14,000 of VAT. £48,000 of cold takeaway sales are zero-rated. Less £3,000 of VAT on purchases.

£11,000

Flat Rate Scheme at 12.5%

12.5% of all £132,000 of turnover, zero-rated sales included. No VAT reclaimed on purchases.

£16,500

In this example the scheme costs the café £5,500 a year. A pub selling mostly standard-rated drink can come out ahead, because the 6.5% rate is set below the VAT it would otherwise pay.

A wet-led pub with all sales standard-rated

Normal VAT accounting

£144,000 of sales including VAT carry £24,000 of VAT. Less £14,000 of VAT on drink and other purchases.

£10,000

Flat Rate Scheme at 6.5%

6.5% of £144,000 of turnover. No VAT reclaimed on purchases.

£9,360

A bed and breakfast with all sales standard-rated

Normal VAT accounting

£110,000 of sales including VAT carry £18,333.33 of VAT. Less £5,000 of VAT on purchases.

£13,333.33

Flat Rate Scheme at 10.5%

10.5% of £110,000 of turnover. No VAT reclaimed on purchases.

£11,550.00

Capital purchases

A business on the scheme can reclaim input VAT on a single purchase of capital goods costing £2,000 or more including VAT, outside the scheme. A new combination oven or a walk-in cold room can qualify. When an asset reclaimed in this way is sold, VAT is charged on the sale in the normal way, outside the flat rate.

Purchases below £2,000, and several cheaper items bought together, stay inside the scheme with no reclaim.

A business that deregisters for VAT leaves the scheme the day before deregistration. On its final return it accounts for VAT outside the scheme on sales made on the last day of registration, and on capital goods and stock still on hand on which it reclaimed VAT when it registered.

Common mistakes and what HMRC does

• Leaving zero-rated or exempt sales out of flat rate turnover.
• Leaving box 4 of the VAT return empty. HMRC's notice lists missing out "None", or £0.00 on an online return, as a common error.
• Applying the percentage to turnover before VAT.
• Choosing the pub rate when food makes up most of the turnover.
• Not checking the limited cost business test each period.
• Staying on the scheme after turnover passes £230,000 including VAT.
• Reclaiming VAT on day-to-day purchases while on the scheme.
• Carrying on with the 1% first-year reduction after the first anniversary of registration.

Where HMRC finds a business used the wrong percentage or stayed on the scheme when it should have left, it assesses the VAT due under the right rules, with interest. A penalty for an inaccurate return can be added where reasonable care was not taken.

Records and deadlines

• Normal VAT records, including VAT invoices issued to VAT-registered customers.
• For each VAT return: flat rate turnover, the percentage used, the tax worked out, and spending on relevant goods for the limited cost test.
• The turnover split behind the choice of sector, reviewed each anniversary.
• VAT records kept for at least 6 years.
• VAT return and payment due one calendar month and 7 days after the end of each VAT period.

Records of sales and purchases on the scheme do not have to split each figure into net, VAT and gross, but they must be complete, orderly and easy to follow. HMRC expects accounts for income tax to show turnover as gross takings less the flat rate VAT, with the VAT on purchases included in expenses.

How we help

We run your figures both ways for a year before you join, and check the sector, the limited cost test and the £230,000 limit each period. Where the scheme costs more than normal accounting, we take you off it. More on accounts and VAT, or try the eat-in and takeaway VAT calculator.