Should You Register for VAT as a Contractor? FRS vs Standard Rate Explained

VAT confuses more contractors than almost any other area of tax. Most know they need to register at some point. Far fewer understand when voluntary registration makes sense, how the Flat Rate Scheme actually works, or why a scheme that saves one contractor £2,600 per year saves another contractor almost nothing.

This guide walks through the registration decision, the FRS vs standard rate calculation, and the specific test that catches most contractors out — the limited cost trader rule.

Do you need to register for VAT?

You must register for VAT when your taxable turnover exceeds £90,000 in any rolling 12-month period. This is the mandatory registration threshold for 2026/27. Two tests apply:

• The backward-looking test: If your rolling 12-month taxable turnover has exceeded £90,000, you must register within 30 days. Your VAT registration becomes effective from the day after the end of the month in which you crossed the threshold.
• The forward-looking test: If you have reasonable grounds to believe your turnover will exceed £90,000 in the next 30 days alone, you must register immediately — effective from the start of that 30-day period.

Should you register voluntarily?

If your turnover is below £90,000, you have the option to register voluntarily. Whether this is worthwhile depends on your client base and your costs.

For most IT and engineering contractors serving business clients, voluntary registration is worth considering from the point your business costs reach meaningful levels — even well below the £90,000 threshold.

Standard rate VAT vs the Flat Rate Scheme

Once registered, you choose your VAT accounting method. The two main options for contractors are:

Standard rate VAT

You charge 20% VAT on your invoices and collect it from clients. You reclaim 20% input VAT on all your business costs. The difference — output VAT collected minus input VAT reclaimed — is what you pay to HMRC each quarter. If your costs are high, standard rate can result in a relatively low net VAT payment.

The Flat Rate Scheme (FRS)

You still charge 20% VAT on invoices. But instead of calculating input and output VAT precisely, you pay a fixed percentage of your gross (VAT-inclusive) turnover directly to HMRC. The FRS percentage is set by sector — for IT contractors it is 14.5%, for management consultants it is 14%, for accountancy it is 14.5%. You keep the difference between the 20% you charged and the flat rate percentage you pay.

The appeal of FRS is simplicity and a potential surplus — particularly for service contractors with low costs who retain more than they hand over.

The FRS calculation: a worked example

An IT contractor with £100,000 annual turnover (excluding VAT) on FRS at 14.5%:

Item	Amount
VAT charged to clients (20%)	£20,000
Gross turnover including VAT	£120,000
FRS payment to HMRC (14.5% × £120,000)	£17,400
FRS surplus retained	£2,600

This looks attractive — £2,600 per year is a meaningful saving for no extra work. But there is a catch.

The limited cost trader rule

HMRC introduced the limited cost trader test in 2017 specifically to prevent low-cost service providers from benefiting too generously from FRS. Under this rule, if your business spends less than 2% of its gross (VAT-inclusive) turnover on goods — or less than £1,000 per year on goods — you are a limited cost trader and must use an FRS rate of 16.5%, regardless of your sector.

The critical word here is goods. Goods means physical items — stationery, postage, raw materials. The following do NOT count as goods for the limited cost trader test:

• Software subscriptions (e.g. Adobe Creative Cloud, Microsoft 365) — these are services
• Professional subscriptions (ICAEW, LinkedIn premium) — services
• Travel, accommodation — services
• Food or hospitality — excluded even if physical
• Capital items like laptops and equipment — capital, not revenue goods

For most service contractors, actual goods spend is minimal — a few pounds of stationery and postage per year, if that. This means most contractors are limited cost traders by default, even if they spend thousands on business costs.

Contractor	Annual Goods Spend	2% of Gross Turnover (£100k+VAT)	Limited Cost Trader?	FRS Rate
IT consultant, mostly software tools	£0 (software = services)	£2,280	Yes — below 2% and £1,000	16.5%
UX designer, buys drawing tablets	£800	£2,280	Yes — below £1,000 threshold	16.5%
Engineering consultant, buys PPE and materials	£3,500	£2,280	No — above 2% test	14.5%

FRS at 16.5% — is it still worth it?

For a limited cost trader on 16.5% FRS, the surplus compared to standard rate narrows dramatically:

Scenario	FRS at 14.5%	FRS at 16.5%	Standard Rate
VAT charged (£100k turnover)	£20,000	£20,000	£20,000
Paid to HMRC	£17,400	£19,800	£20,000 − input VAT
Input VAT on costs (est. £2k software/equipment)	N/A (not reclaimable)	N/A	−£400
Net VAT to HMRC	£17,400	£19,800	£19,600
Annual surplus vs standard	+£2,600	−£200 (worse)	Baseline

At 16.5%, FRS is slightly worse than standard rate for most limited cost traders. The £200 difference is negligible in cash terms — but switching to standard rate also gives you input VAT reclaim on future equipment purchases that FRS does not.

Common VAT mistakes contractors make

• Missing the registration deadline — the rolling 12-month test catches contractors off-guard. Monitor your cumulative turnover against £90,000 monthly.
• Staying on FRS when they've become a limited cost trader — your cost profile can change year to year. Review your FRS status annually.
• Treating reimbursed expenses as outside VAT scope — if you invoice a client for expenses and add a mark-up, VAT may be due. Genuine disbursements (paid on behalf of the client, at cost, no mark-up) are treated differently.
• Forgetting to de-register when turnover drops — once registered, you can apply to de-register when your taxable turnover drops below the de-registration threshold of £88,000.
• Place of supply errors for overseas clients — if you provide services to a business customer outside the UK, the place of supply may be outside the UK scope. The reverse charge mechanism can apply. Take advice on this if you have non-UK business clients.

Practical setup: MTD for VAT

All VAT-registered businesses must file VAT returns digitally under Making Tax Digital (MTD). This means using MTD-compatible software — FreeAgent is fully MTD compliant and handles quarterly VAT returns submission directly to HMRC. If you're registered for VAT and using FreeAgent, your quarterly return submission is largely automated once your bookkeeping is up to date.

VAT returns are typically due one month and seven days after the end of each quarter. A quarterly filing cycle is standard; monthly filing is available (and sometimes beneficial) for businesses that regularly receive VAT refunds.

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