Journey

Choosing the right VAT scheme

Compare VAT schemes and choose the best one for your business. This learning path takes you through the three main VAT schemes for small businesses - Flat Rate, Cash Accounting, and Annual Accounting - helping you understand which suits your circumstances.

Starting Updated 2 November 2026

What you will learn

Once you are VAT registered, you have a choice about how you account for VAT. The standard method requires calculating VAT on every transaction, but HMRC offers three alternative schemes designed for smaller businesses.

This learning path helps you:

Understand when a VAT scheme could benefit your business
Compare the Flat Rate Scheme, Cash Accounting, and Annual Accounting
Choose the right scheme based on your business type and cash flow

Understand your VAT scheme options

Start by understanding what schemes are available and how they differ from standard VAT accounting. Each scheme simplifies VAT in a different way, and the right choice depends on your business type, payment patterns, and administrative preferences.

VAT schemes: choosing the right one for your business

Overview of all four approaches to VAT accounting - standard, Flat Rate, Cash Accounting, and Annual Accounting - with eligibility criteria and when each works best.

Quick comparison of VAT schemes

Here is how the main approaches compare at a glance:

Standard VAT

Pay VAT on invoices issued. Reclaim VAT on purchases in full.

Flat Rate Scheme

Pay fixed % of turnover. Cannot reclaim VAT on most purchases. Turnover max: £150,000.

Cash Accounting

Pay VAT when customers pay you. Helps cash flow. Turnover max: £1.35 million.

Annual Accounting

File one VAT return per year. Make advance payments. Turnover max: £1.35 million.

VAT schemes (opens in a new tab)

Guv’s take

Standard VAT is the default. You must actively apply to use any alternative scheme. If you do nothing, you will use standard VAT accounting.
Consider the Flat Rate Scheme

The Flat Rate Scheme is the most significant departure from standard VAT. Instead of tracking VAT on every transaction, you pay a fixed percentage of your turnover based on your business sector. This can save time and, for some businesses, reduce your VAT bill.

Join the VAT Flat Rate Scheme

How the Flat Rate Scheme works, finding your sector percentage, the limited cost trader rules, and calculating whether it would benefit your business.

Flat Rate Scheme thresholds

Key eligibility and exit thresholds for the Flat Rate Scheme:

The VAT Flat Rate Scheme simplifies VAT accounting for small businesses. Instead of calculating VAT on each transaction and reclaiming input VAT on purchases, you pay HMRC a fixed percentage of your gross (VAT-inclusive) turnover based on your business type.

Turnover limit to join

£150,000 or less expected in next 12 months

First-year discount

1% off your flat rate in your first year of VAT registration

Input VAT recovery

Not on most purchases; capital assets over £2,000 are the exception

Leaving

At any time; you must leave if you stop being eligible, or if your turnover including VAT was more than £230,000 in the last 12 months (checked on the anniversary of joining) or you expect it to be in the next 12 months

Rejoining

Wait 12 months after leaving

Cash Accounting Scheme

Cannot be used with the Flat Rate Scheme

VAT groups

Not eligible if you joined or could have joined one in the last 24 months

VAT Flat Rate Scheme (opens in a new tab)

Best suited for

Businesses with low purchase costs who want simple administration

Not suited for

Service businesses classified as 'limited cost traders' (must use 16.5% rate)

Cannot combine with

Cash Accounting Scheme (it can be used with Annual Accounting)

Take note

Check the limited cost trader rules carefully. If you spend less than 2% of turnover on goods, you must use the 16.5% flat rate regardless of your sector. This often makes the scheme more expensive than standard VAT accounting.
Consider Cash Accounting
Cash Accounting changes when you account for VAT, not how you calculate it. Instead of paying VAT when you issue invoices, you pay it when customers actually pay you. This can significantly improve cash flow if you give credit to customers.

Use VAT Cash Accounting

How Cash Accounting improves cash flow, eligibility criteria, record keeping requirements, and when to consider leaving the scheme.
Cash Accounting Scheme details

Key features and thresholds for the Cash Accounting Scheme:
The Cash Accounting Scheme allows VAT-registered businesses to account for VAT based on when payments are received and made, rather than when invoices are issued. This can significantly improve cash flow for businesses that give credit to customers.

Entry threshold

Taxable turnover must not exceed £1.35 million in the next 12 months

Exit threshold

Must leave if taxable turnover exceeds £1.6 million

When to leave

At the end of the VAT period in which turnover exceeds £1.6 million

VAT payment timing

Pay VAT to HMRC when customers pay you

VAT reclaim timing

Reclaim VAT on purchases when you pay your suppliers

How Cash Accounting works

Under standard VAT accounting, you account for VAT when you issue or receive an invoice, regardless of whether payment has been made. Under Cash Accounting:

Output tax: Account for VAT when you receive payment from customers, not when you invoice them

Input tax: Reclaim VAT when you pay suppliers, not when you receive their invoice

This means you never pay VAT to HMRC before you have received it from your customers.

Who Cash Accounting suits

Businesses that offer credit terms to customers (30, 60, or 90 days)

Businesses with slow-paying customers

Businesses with cash flow concerns

Businesses that pay suppliers more quickly than customers pay them

Who Cash Accounting may not suit

Businesses that receive payment before or at the point of sale (retail, hospitality)

Businesses that pay suppliers on longer credit terms than they offer customers

Businesses that want to reclaim VAT on large purchases immediately

Cash flow benefit

Do not pay VAT on unpaid invoices or bad debts

Bad debt protection

Automatic - you only pay VAT on amounts actually received

Joining the scheme

No application required - simply start using Cash Accounting

Notification to HMRC

Not required when joining or leaving

Record keeping requirements

Under Cash Accounting you must keep records that show:

The date of each payment received from customers

The date of each payment made to suppliers

The amount of VAT included in each payment

How payments relate to specific invoices (if partial payments)

Standard VAT records must also be kept for at least 6 years.

Interaction with other VAT schemes

Flat Rate Scheme: Cannot use Cash Accounting with Flat Rate Scheme (but Flat Rate has its own cash-based option)

Annual Accounting Scheme: Can be used together with Cash Accounting

VAT Margin Scheme: Cannot use Cash Accounting for margin scheme goods

Flat Rate Scheme compatibility

Not compatible - but Flat Rate has its own cash-based payment option

Annual Accounting compatibility

Compatible - can use both schemes together

Margin Scheme compatibility

Not compatible for margin scheme goods

Standard retention period

Keep all VAT records for at least 6 years

Leaving the scheme

You must leave Cash Accounting if your taxable turnover exceeds £1.6 million. You should also consider leaving if:

Your payment patterns change (e.g., you move to payment upfront)

You want to reclaim VAT on a major purchase immediately

You join the Flat Rate Scheme

When leaving, you must account for VAT on all outstanding invoices (issued but not yet paid) in your first VAT return under standard accounting.

VAT Cash Accounting Scheme (opens in a new tab)
Best suited for

Businesses that give credit terms and have slow-paying customers

Not suited for

Retail or hospitality where customers pay immediately

Key benefit

Automatic bad debt protection - no VAT due on unpaid invoices

Can combine with

Annual Accounting Scheme (for maximum simplification)

Guv’s take

No application required. Unlike Flat Rate, you can start using Cash Accounting without HMRC approval. Simply begin using it from the start of any VAT period.
Consider Annual Accounting

Annual Accounting reduces your VAT return frequency from four times per year to once. You make advance payments throughout the year based on your estimated VAT bill, then settle any balance when you file your annual return.

Entry threshold

Taxable turnover £1.35 million or less

Exit threshold

Must leave if turnover exceeds £1.6 million

Payment options

9 monthly payments of 10%, or 3 quarterly payments of 25%

Final return deadline

2 months after your accounting year ends

Best suited for

Businesses with predictable turnover who want less admin

Not suited for

Businesses that regularly receive VAT refunds (fewer refunds per year)

Can combine with

Cash Accounting Scheme

Guv’s take

Combining schemes: You can use Cash Accounting and Annual Accounting together for maximum simplification - cash-based VAT timing plus only one return per year. However, you cannot combine either with the Flat Rate Scheme.
Choose the right scheme for your business
The best scheme depends on your specific circumstances. Use these questions to guide your decision.
1. Do you have significant VAT-able purchases?
  
  If yes, avoid the Flat Rate Scheme (you cannot reclaim VAT on most purchases). Standard accounting or Cash Accounting lets you reclaim input VAT in full.
2. Are you a service business with few material costs?
  
  Check the limited cost trader rules. If you spend less than 2% of turnover on qualifying goods, Flat Rate would require the 16.5% rate - usually more expensive than standard VAT.
3. Do customers take time to pay you?
  
  Cash Accounting helps if customers pay on credit terms (30, 60, 90 days). You only pay VAT when you receive payment, improving cash flow.
4. Do you receive regular VAT refunds?
  
  If you typically reclaim more VAT than you pay (common for exporters or businesses with zero-rated sales), avoid Annual Accounting (only one refund per year) and consider whether Cash Accounting delays your refunds.
5. Is admin time a significant burden?
  
  Flat Rate Scheme removes transaction-by-transaction VAT calculations. Annual Accounting reduces returns from four to one per year. Both save time.
6. Are you growing rapidly?
  
  Check turnover thresholds. You will outgrow Flat Rate Scheme at £230,000. Cash Accounting and Annual Accounting have higher limits (£1.6 million exit threshold).
Common scenarios

IT consultant with few expenses: Check the limited cost trader rules first. If you qualify as a limited cost trader (16.5% rate), standard VAT is likely cheaper. If not, compare your sector's flat rate against your effective VAT rate.

Trade business with payment delays: Cash Accounting is often beneficial. You may wait 30-60 days for customer payment; Cash Accounting means you do not pay VAT until they pay you.

Retailer with cash sales: Cash Accounting provides little benefit (customers pay immediately). Consider whether your sector's flat rate percentage would save money compared to standard VAT.

Business with steady turnover and limited admin time: Annual Accounting reduces paperwork. Combine with Cash Accounting if customers also pay on credit terms.

Summary: Which VAT scheme suits your business?

Flat Rate Scheme: Best for businesses with low expenses and high margins. Simple admin but no input VAT recovery. Avoid if limited cost trader (16.5% rate).
Cash Accounting: Best for businesses with payment delays. Pay VAT when paid, automatic bad debt protection. No benefit for immediate payment businesses.
Annual Accounting: Best for predictable turnover and less admin. One return per year, advance payments. Avoid if you regularly receive refunds.
Standard VAT: Best for businesses with significant purchases to reclaim, or those who do not fit neatly into alternative schemes.

What to do next

Once you have decided which scheme suits your business:

Flat Rate Scheme: Apply through your HMRC business tax account. Wait for confirmation before using the scheme.
Cash Accounting: Start using it from your next VAT period. No application needed.
Annual Accounting: Apply through your HMRC business tax account or using form VAT600AA.
Standard VAT: This is the default - no action required.

If you are still unsure, consider speaking to an accountant who can analyse your specific figures and recommend the most cost-effective approach.

I understand the difference between standard VAT and the alternative schemes I have checked whether I qualify as a limited cost trader (affects Flat Rate) I know my typical payment terms and whether Cash Accounting would help I have considered whether I regularly receive VAT refunds (affects Annual Accounting) I have compared my likely VAT bill under different schemes I know which schemes can be combined (Cash + Annual) and which cannot (Flat Rate) I have decided which scheme to use and know how to apply

Official guidance

VAT Flat Rate Scheme (opens in a new tab)

Full details including how to join and flat rate percentages by sector

GOV.UK

VAT Cash Accounting Scheme (opens in a new tab)

How to use Cash Accounting and when you must leave

HMRC

VAT Annual Accounting Scheme (opens in a new tab)

Payment schedules and how to apply

GOV.UK

VAT schemes overview (opens in a new tab)

Quick comparison of all available VAT schemes

GOV.UK

Choosing the right VAT scheme

What you will learn

Understand your VAT scheme options

VAT schemes: choosing the right one for your business

Consider the Flat Rate Scheme

Join the VAT Flat Rate Scheme

Consider Cash Accounting

Use VAT Cash Accounting

Consider Annual Accounting

Choose the right scheme for your business

Do you have significant VAT-able purchases?

Are you a service business with few material costs?

Do customers take time to pay you?

Do you receive regular VAT refunds?

Is admin time a significant burden?

Are you growing rapidly?

Common scenarios

Summary: Which VAT scheme suits your business?

What to do next

Official guidance

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