Practical guide: when should you leave a VAT scheme?

Higher exit thresholds

A key point with the three main VAT schemes is that the leaving threshold is higher than the joining limit in each case. The schemes are: cash accounting (CAS); annual accounting (AAS); flat rate (FRS). It is important that you are aware of the relevant thresholds so that you don’t leave too early or late. But in other cases, it might be in your interests to leave if trading circumstances change.

If you leave the FRS or AAS, you must notify HMRC in writing. But there is no need to tell HMRC if you are leaving the CAS. You can only leave the CAS at the end of a VAT period, not part-way through.

CAS: the basics

The main advantage of the CAS is that output tax is not included on a VAT return until the customer has paid. This is a cash-flow winner if you have customers who take a long time to pay their invoices. The scheme also gives automatic bad debt relief. However, the main downside is that you cannot claim input tax on your returns until you have paid suppliers.

If you are paid promptly by customers but take time to pay your suppliers, the CAS might not be worthwhile. You must weigh up the output tax “win” against the input tax “loss” in this situation.

Six-month exit process

You must leave the CAS at the end of any VAT period where taxable sales for the previous twelve months have exceeded £1.6 million excluding VAT. The exit figure must include any sales of stock and capital assets. You must adopt accruals VAT accounting for the period of departure, accounting for output tax on closing debtors and claiming input tax on closing creditors.

For many businesses, the reversion to accruals-based accounting could produce a potential cash-flow problem. You can instead account for VAT on debtors and creditors over the next two quarters, as payments are made and received.

Example. Handbags Ltd had to leave the CAS on 30 June 2022 because its taxable sales for the twelve months to that date were £2 million excluding VAT. Its closing debtors are £150,000 plus VAT and standard- rated creditors are £70,000 plus VAT. It is expected that 80% of the debtors and creditors will pay and be paid in the September quarter and the other 20% in December. Instead of accounting for output tax of £30,000 and claiming input tax of £14,000 in the June period, the VAT can instead be declared as follows:

• September 2022 return - output tax £24,000; input tax £11,200; net payment £12,800
• December 2022 return - output tax £6,000; input tax £2,800; net payment £3,200.

If any sales invoices are still unpaid at the end of September in this example, the VAT must be included on the December 2022 return. But the unpaid invoices might now qualify for bad debt relief if they are more than six months overdue for payment, and have been written off in the sales ledger records.

Temporary turnover increase

There is an opportunity to remain in the CAS if you are satisfied that taxable sales in the next twelve months after going over the exit limit will not exceed the joining threshold, i.e. £1.35 million excluding VAT. There is no need to write to HMRC but you should keep a clear record about why the threshold was exceeded temporarily.

Example. Accountants Ltd usually has annual taxable sales of £1.2 million excluding VAT, which is less than the CAS exit threshold of £1.6 million. However, in the VAT period June 2022, they sold the freehold of their office premises for £1 million plus VAT. However, this is a one-off sale and their taxable sales in the next twelve months are expected to revert to £1.2 million excluding VAT. They can therefore remain in the scheme.

AAS: the basics

The main advantage of the AAS is that you will only submit one return each year instead of four quarterly returns. It is particularly useful for businesses who have a track record of incurring default surcharges with the quarterly submissions.

However, payments on account are still needed throughout the accounting year, based on the net liability on the previous year’s return. The annual return and balancing payment are due within two months of the end of the accounting year. If the payments on account to HMRC are too high or low, they can be adjusted.

Exit threshold

The AAS exit threshold is the same as for the CAS, i.e. you must withdraw if the annual return shows that taxable sales have exceeded £1.6 million excluding VAT. HMRC will write to you to confirm the change to quarterly accounting from the beginning of the next period. However, you can remain in the scheme if you can satisfy HMRC that taxable sales in the next twelve months will be less than £1.35 million excluding VAT.

FRS: the basics

The basis of the FRS is that you will apply a fixed percentage to gross sales in a period, the percentage depends on the business activity. You must include zero-rated and exempt sales in the calculations but not sales that are outside the scope of VAT. 

The main advantage of the FRS is the simplified reporting, though there can be VAT savings in some circumstances too.

You must leave the FRS if gross sales including VAT have exceeded £230,000 on the anniversary date of joining the scheme. Capital asset sales are excluded from this. However, if total sales including VAT are expected to be less than £191,500 in the next twelve months, you can ask HMRC to remain in the scheme.

Change in trading circumstances

You might have encountered a change in trading circumstances which means that the continued use of a VAT scheme is no longer in your best interests. Here are two possible reasons:

Increased zero-rated or reduced rate sales . For example, a builder might decide to work for developers building new dwellings (zero-rated) instead of working on commercial properties (standard-rated). It would therefore be sensible to withdraw from all three schemes:

• the FRS includes zero-rated income in the tax payable calculation, even though no VAT is being charged to customers
• the CAS will have no cash-flow benefits if there is minimal output tax on sales
• it will be sensible to submit monthly returns to reclaim input tax quicker, rather than waiting to submit annual returns with the AAS.

Fluctuating VAT rates on sales. What would happen if you do not know the mix of standard and zero-rated sales in a typical VAT period? In this situation, the FRS would certainly produce a bad outcome because of the inclusion of zero-rated sales in the tax payable calculations, as explained above. The other two schemes would also produce potential problems, so a voluntary withdrawal might be the best solution.

Remember, if you choose to leave the AAS or FRS, you cannot rejoin for at least twelve months.