The problem with e-commerce is that a large proportion of your spending is on Google ads or other marketplace fees, like eBay, Amazon or ETSY. This means that around 30-50% of your cost is non-reclaimable.
Let’s look at what you might see on an example VAT return:
Example Normal VAT scheme (20% VAT Rate)
UK Revenue £10,000 = £1667 payable VAT (output VAT)
Cost of Goods £2000 = £333 Reclaimable VAT (input VAT)
Facebook Marketing Spend £2000 = £0 VAT reclaimable (input VAT)
Amazon Seller fees £1000 = £0 VAT reclaimable. (input VAT)
Therefore your business pays £1,334 in VAT to HMRC
This is an effective VAT rate of 13%!!! So 13% of your sale price is being paid to HMRC. This dilutes your margin and can mean your profit margins are tight and we know that many e-commerce businesses are operating on minimal margins to stay competitive on marketplaces.
This means that by being a VAT-registered business, you are now at a disadvantage against non-VAT Registered businesses. You will likely have to change prices to remain profitable, but this may mean you no longer compete and you lose sales, a bit of a catch-22 situation! But one that many businesses face when trading online.
Flat Rate Scheme
One of the VAT schemes we use for our e-commerce clients is called the flat rate scheme. With the flat rate scheme, HMRC allows you to use a set percentage (%) of your sales as your VAT bill rather than calculating VAT on every transaction in and out.
The VAT Flat Rate Scheme, aimed at easing the burden of VAT return preparation for small businesses and limited companies, was unveiled by HM Revenue and Customs in the 2002 Budget. This initiative was specifically designed to assist small business owners in mitigating their administrative challenges. E-commerce businesses can also use this scheme to work in their favour and improve margins.
The flat rate percentage depends on what type of business you are. For example, for E-commerce businesses, the correct flat rate percentage is 7.5%, which is a great saving on the example above where we show the effective VAT rate of 13%! By using the flat rate vat scheme in your e-commerce business, you will be as tax efficient as you can be when it comes to VAT registration and also make your VAT returns much simpler.
Example of Flat Rate scheme VAT using the same figures
UK Revenue £10,000 = £750 Payable VAT (7.5% flat rate)
No other costs are reclaimable
Therefore your business pays £750 to HMRC
By using the flat rate scheme as your method of VAT return you get an effective vat rate of just 7.5%, so your margin erosion has been nearly halved just by choosing the correct VAT scheme – all totally legal and above board.
Wait, there’s more savings…
One of the additional benefits you get is that in the first year of being on the flat rate scheme, you will also have a 1% discount on the 7.5%. This means you will only pay 6.5% of your sales in your first year. This would mean you are only paying £650 in VAT by using the flat rate scheme; this saving lasts your entire first year of registering for the VAT flat rate scheme.
By understanding your cost base and which items can be reclaimed or not can make sure you choose the right scheme for you, saving your money, maintaining margins and allowing you to grow.
Small business owners rarely use this scheme or even realise it’s there to use; we know that understanding VAT can be a complex task, particularly for new and small business owners. The UK’s HMRC Flat Rate Scheme (FRS), which we will call the FRS, offers a simpler way to handle VAT. It provides a viable option for e-commerce businesses to manage their VAT payments efficiently and, as seen in the examples above, it’s not just money saving but also time saving.
The Basics of the VAT FRS
VAT FRS allows a business to pay VAT as a Fixed Rate VAT of its sales turnover, with Flat Rate VAT Percentages determined by the business type. E-commerce businesses fall under the category “Retailing not listed elsewhere” and are given a Flat Rate VAT Percentage of 7.5%.
The scheme negates the need for a business to document and report the VAT charged on every sale and purchase. This reduction in administrative burden and limited cost makes the VAT Flat Rate Scheme an attractive scheme for many small businesses.
However, businesses must be aware that under the Flat Rate Scheme, they cannot reclaim VAT on their own purchases, except for certain capital assets over £2,000.
FRS for E-commerce Businesses
The main advantage for e-commerce businesses choosing the Flat Rate VAT is the potential financial benefit, particularly in the first year. For VAT-registered businesses in their first year, a 1% discount is applied, reducing the difference between Flat Rate Scheme Percentages to 6.5% for e-commerce businesses.
To understand this practically, consider an e-commerce business owner selling customers a product for £100. Under the standard VAT scheme, the owner adds a 20% VAT, making goods cost a total of £120. Out of this £120, £20 is the VAT they would typically need to repay.
But under the VAT FRS, this changes. Instead of repaying the full £20, the e-commerce business owner would only need to repay VAT of 6.5% of the gross payment (including VAT), which is £7.32. This results in a small amount but substantial savings for the business owner, especially over multiple transactions.
It’s essential to note that this discount is only applicable for the first year. From the second year onwards, the Flat Rate VAT Percentages would revert to the standard flat rates of 7.5%, still providing a benefit over the usual 20% VAT repayment.
Below is an example of different flat rates for different business types:
Flat Rate Scheme Eligibility
To be eligible for a fixed percentage under the HMRC Flat Rate Scheme, a business must be VAT-registered, and its VAT taxable turnover is expected to be £150,000 or less (excluding VAT) in the next 12 months. This is the Flat Rate VAT Threshold. The flat rate percentage scheme has specific exceptions, including certain previous offences and associations with other businesses.
While VAT FRS has clear benefits, it may not suit every business model. It’s crucial to consider your business structure and consult an e-commerce-specialised accountant or tax advisor to decide if the Flat Rate Scheme is the right choice for your business. If your e-commerce business meets the Flat Rate Scheme Eligibility and can gain from the scheme, it could be a game-changer limited cost business, simplifying your VAT process and reducing your VAT payments.
In conclusion, the VAT Flat Rate Scheme offers an attractive option for small e-commerce businesses looking to simplify their VAT procedures and other costs and potentially save money. By understanding the scheme, its benefits and limitations, e-commerce businesses can make an informed decision and potentially leverage VAT FRS for their benefit.
Leaving the Flat Rate scheme
The threshold for leaving the Flat Rate Scheme (FRS) is when your total business income in the previous 12 months exceeds £230,000 (including VAT). However, you can voluntarily leave the scheme at any time if you believe it is no longer beneficial for your business. It is important to consult with a qualified accountant to assess your specific circumstances before making a decision to leave the FRS.
After you leave the flat rate scheme, you will be back on the normal VAT scheme, where you would be paying 20% on sales and reclaimable VAT on vatable purchases.
Hopefully, by the time you leave the flat rate scheme, your revenue will mean that you can manage with lower margins and can continue growing your business.
Here to help you
Remember, while the VAT Flat Rate Scheme can offer significant benefits, it’s always essential to seek professional advice based on your specific business needs and circumstances before making any substantial changes to your VAT procedures.
Here at Your Ecommerce Accountant, we specialise in accounting for e-commerce businesses that operate on their own websites and various online marketplaces like eBay, Amazon, and ETSY. We understand the unique financial landscape of e-commerce and are dedicated to assisting you in navigating through it.
We offer a fixed monthly cost accounting and bookkeeping service that’s designed to help streamline your business finances and let you focus more on what you do best – growing your business.
We’re not just about numbers; we’re about fostering a partnership that allows your business to flourish in an ever-evolving digital marketplace. So, whether you have questions about this article, are contemplating a switch to a specialised e-commerce accountant, or have tax or accounting inquiries, we are here for you. We invite you to book a free 30-minute consultation with us.
During this session, we’ll answer any questions you have and show you how our services can be tailored to meet your unique business needs. Our aim is to ensure that your e-commerce business not only survives but thrives in the complex financial world of online retail.
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