What counts as a Limited Cost Trader?

A business whose VAT-inclusive cost of relevant goods is less than 2% of VAT-inclusive turnover, or less than £1,000 a year (pro-rated for periods shorter than a year).

Can a client switch out of the FRS mid-year?

Yes — they can leave at any time by writing to HMRC. They must leave when total income exceeds £230,000 in any 12 months.

VAT Flat Rate Scheme: still worth it after the Limited Cost Trader rules?

20 April 2026·5 min read

The Flat Rate Scheme used to be a quiet win for service businesses. Then HMRC introduced the Limited Cost Trader category in April 2017, forcing most consultants, IT contractors and freelancers onto a 16.5% flat rate. After that rate, FRS usually loses you money.

The maths

On standard VAT, you reclaim input VAT on purchases. On FRS, you charge 20% VAT to customers but pay HMRC a flat percentage of your gross (VAT-inclusive) turnover.

At 16.5%, a £100 + VAT invoice generates:

Output VAT charged: £20
Owed to HMRC: 16.5% × £120 = £19.80
Net VAT cost to the business: £0.20

Compared to standard accounting, where you'd typically recover £5–£15 of input VAT a quarter, the LCT rate almost always loses.

Who still benefits

Trades with significant goods purchases — caterers, retailers, builders
New businesses in their first year (1% discount on the FRS rate)
Businesses on a sector rate below 11% with low input VAT

What to do at year-end

For every client still on FRS, run the LCT test against the latest 12 months of purchases. If they're a Limited Cost Trader and on 16.5%, switching to standard accounting is almost always worth it. Write to HMRC, leave on the chosen date, and reclaim input VAT going forward.

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FAQs

What counts as a Limited Cost Trader?: A business whose VAT-inclusive cost of relevant goods is less than 2% of VAT-inclusive turnover, or less than £1,000 a year (pro-rated for periods shorter than a year).
Can a client switch out of the FRS mid-year?: Yes — they can leave at any time by writing to HMRC. They must leave when total income exceeds £230,000 in any 12 months.