A UK VAT-registered business uses the Flat Rate Scheme. In a return period, its VAT-inclusive spending on relevant goods is 1.5% of its VAT-inclusive flat rate turnover for that period. Under HMRC's limited cost trader test in VAT Notice 733, what flat rate percentage must this business apply to its VAT-inclusive turnover for that period, ignoring any first-year discount?
- Its normal sector-specific flat rate percentage, because 1.5% of turnover is enough spending to avoid the limited cost trader rate
- 16.5%, because spending below 2% of VAT-inclusive turnover on relevant goods makes it a limited cost trader regardless of its business sector
- 20%, the standard VAT rate, because failing the limited cost trader test means the Flat Rate Scheme no longer applies to the business at all
- 0%, because spending below 2% of turnover on goods means the business is treated as making no taxable supplies for that period
Why B? And why not the others?
Correct answer: B. 16.5%, because spending below 2% of VAT-inclusive turnover on relevant goods makes it a limited cost trader regardless of its business sector
HMRC's limited cost trader test classifies a Flat Rate Scheme user as a limited cost trader if its VAT-inclusive spending on relevant goods is below 2% of its VAT-inclusive flat rate turnover, and at 1.5% this business falls squarely below that 2% threshold, so it must use the fixed 16.5% rate regardless of which sector it operates in. The option applying the normal sector rate wrongly treats 1.5% as sufficient spending to escape the limited cost trader rule, when in fact anything below the 2% line triggers the higher flat rate. The option jumping to the 20% standard rate misunderstands the consequence of failing the test: being a limited cost trader changes which flat rate percentage applies within the scheme, it does not remove the business from the Flat Rate Scheme or push it onto standard-rate accounting. The option treating the business as making no taxable supplies confuses low goods spending with having no sales at all; the limited cost trader test is about the ratio of qualifying goods purchases to turnover, not about whether the business is trading or making taxable supplies.
Source: GOV.UK: Flat Rate Scheme for small businesses (VAT Notice 733)