Limited Cost Trader Rule: What It Means for Contractors

What is a limited cost trader?

A limited cost trader is a business whose VAT-inclusive expenditure on goods (not services) is either:

• Less than 2% of VAT-inclusive turnover, or
• Less than £1,000 per year (even if this is more than 2% of turnover)

If you meet either condition, HMRC requires you to use the 16.5% flat rate regardless of your sector — which is higher than almost every other sector rate.

Why most contractors are affected

Contractors typically spend very little on physical goods. Software subscriptions, cloud services, and professional services are all classified as 'services' — not goods — for this test. The goods test is narrow: physical items like office stationery, hardware, equipment.

An IT consultant invoicing £10,000/month who buys £50 of printer paper is almost certainly a limited cost trader.

The financial impact

At 14.5% (IT sector rate), the monthly surplus on £12,000 VAT-inclusive turnover is £2,000 − (£12,000 × 14.5%) = £260. At 16.5%, the surplus is £2,000 − £1,980 = just £20. In practice, most limited cost traders find the FRS makes no meaningful difference — or costs them money when compliance time is factored in.

What should limited cost traders do?

Leave the Flat Rate Scheme and use standard VAT accounting. On standard VAT, you pay the difference between VAT collected and VAT on eligible business purchases. For most low-expense businesses, this means paying the full 20% collected (you reclaim little input VAT) — but you avoid the 16.5% rate and the compliance headache of checking limited cost trader status every quarter.