A Limited Cost Trader is a business that uses the VAT Flat Rate Scheme but spends very little on goods.
HMRC introduced this rule on 1 April 2027, which requires certain businesses to apply a higher flat rate of 16.5%. This rate applies to your VAT-inclusive turnover, not your profit.
As a result, many businesses lose the financial benefit that the Flat Rate Scheme once offered. This mainly affects service-based businesses, such as consultants and contractors.
How the Flat Rate Scheme Works
The Flat Rate Scheme aims to simplify VAT reporting for smaller businesses. It removes the need to track VAT on every purchase.
Instead, you:
- Charge your customers the standard 20% VAT
- Apply a fixed percentage to your VAT-inclusive turnover
- Pay that amount directly to HMRC
This reduces admin work and improves consistency in VAT calculations.
In many cases, businesses keep the difference between the VAT they charge and the flat rate they pay. However, the Limited Cost Trader rule often removes this advantage.
How to Know If You Are a Limited Cost Trader
You must check your spending on goods for each VAT period. Most businesses submit VAT Returns every quarter, so you should review this regularly.
You qualify as a Limited Cost Trader if your spending on goods is either:
- Less than 2% of your VAT-inclusive turnover
- Less than £1,000 per year (adjusted if your accounting period is shorter)
Both conditions work together, so many small businesses fall into this category, even if they spend something on goods.
For example: A business with lower turnover may still fail the test because of the £1,000 minimum threshold.
What Counts as Goods
HMRC uses a strict definition of goods. Only physical items used directly for your business count.
Qualifying Goods
- Office consumables (such as pens and printer ink)
- Cleaning products used in the workplace
- Materials or stock used directly in services
These items must be “Wholly and Exclusively” for business purposes.
Non-Qualifying Goods
- Software subscriptions and digital goods
- Cloud services and online platforms
- Phone and internet bills
- Rent and utilities
- Food and drink for staff or clients
- Vehicles, fuel and travel costs (unless in transport businesses)
- Accountancy, legal and professional fees
- Training courses and certifications
- Capital items over £2,000
Most everyday business costs do not qualify. Because of these restrictions, most service-based businesses struggle to meet the threshold.
The Reasoning Behind the Limited Cost Trader Rule
HMRC introduced the Limited Cost Trader rule to reduce tax advantages within the Flat Rate Scheme. Before 2017, many service-based businesses benefitted from lower flat rates.
For example: A contractor could charge 20% VAT but pay a lower flat rate, such as 14.5%.
This difference created extra income, but HMRC believed that this was an unfair advantage. As a result, the 16.5% rate removed most of the benefit. The change shifted the scheme towards businesses that regularly purchase and sell goods.
What Happens If You Are a Limited Cost Trader
If your business meets the criteria, you must apply the 16.5% rate.
You need to:
- Apply 16.5% to your VAT-inclusive turnover
- Ignore your sector’s standard flat rate
- Reassess your position every VAT period
If you apply the wrong rare, you may underpay VAT and face penalties.
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This article is for general informational purposes only and does not constitute legal or financial advice. While we aim to keep our content up to date and accurate, UK tax laws and regulations are subject to change. Please speak to an accountant or tax professional for advice tailored to your individual circumstances. Pi Accountancy accepts no responsibility for any issues arising from reliance on the information provided.