The Limited Cost Trader Test: Avoiding the 16.5% Flat Rate

The Limited Cost Trader test was introduced in April 2017 to stop the Flat Rate Scheme from being used as a planning tool by businesses with almost no goods spend. The test is mechanical: every period a business on FRS has to ask whether its spend on relevant goods is below either 2 percent of VAT-inclusive turnover, or below £1,000 a year. If yes, the business is a Limited Cost Trader for that period and must use the 16.5 percent flat rate instead of its ordinary sector rate. The 16.5 percent rate is set high enough to leave only a few tenths of a percent of FRS gain on each pound of turnover. This guide is part of the UK VAT schemes hub and sits alongside its sister piece on whether FRS is still worth it in 2026.

This article walks through the LCT test step by step, defines what counts as relevant goods and what does not, sets out the period-by-period mechanics, models the 16.5 percent trap with worked numbers, and lays out the practical options for service businesses that consistently fail the test.

What the Limited Cost Trader test actually is

The test is built around one phrase: relevant goods. In each VAT period, a business on FRS measures its spend on relevant goods against two thresholds. If the spend is less than 2 percent of VAT-inclusive turnover for the period, or if it is more than 2 percent but less than £1,000 a year on a pro-rata basis (£250 in a quarterly period), the business is a Limited Cost Trader for that period and applies 16.5 percent instead of its sector rate.

The test is applied per VAT period, not annually as a one-shot exercise. A business can be a Limited Cost Trader in one quarter and out of the test in the next, depending on its goods spend. The flat rate used on each return reflects the classification for that period, not for the year.

Why the rate is set at 16.5%

On 20 percent VAT-inclusive turnover, the maximum the FRS percentage can theoretically be is the VAT element itself, that is, 100 divided by 120, which is roughly 16.67 percent. HMRC set the LCT rate at 16.5 percent, leaving a fraction of a percent of FRS gain on each pound of turnover. The clear policy intent is to make FRS uneconomic for businesses with no real goods spend, so they revert to standard accounting and stop using FRS as a saving tool.

On a £100 net sale, output VAT is £20 and VAT-inclusive turnover is £120. At 16.5 percent, the FRS payment is £19.80, leaving £0.20 of FRS gain per £100 of net turnover before any input VAT is given up. After the lost input VAT on ordinary expenses, the LCT business is almost always behind where it would be on standard accounting.

What counts as relevant goods

Relevant goods are physical items used wholly and exclusively for the purposes of the business. Services do not count at all. Some categories of goods are specifically excluded even though they are physical. The definition is deliberately narrow.

• Stationery, office consumables, raw materials and stock for resale generally count.
• Tools used in the trade and small equipment used in the work generally count.
• Cleaning supplies for business premises generally count.
• Software downloads, subscriptions and services do not count.
• Food and drink for staff or proprietors does not count.
• Fuel for road vehicles does not count, except for genuine transport businesses.
• Goods bought to give away or for resale at a loss for marketing purposes do not count.
• Capital expenditure such as plant, computers and equipment does not count toward the LCT test, even though some of it may be reclaimable under the FRS capital goods exception.

Service businesses and the structural LCT problem

For service businesses, the rules are punishing. A consultancy, a remote software business, a coach or trainer, a designer working from a laptop, a virtual assistant, almost any business whose deliverable is intellectual rather than physical, has little or no relevant goods spend by definition. Subscriptions, cloud tools, professional fees and training are services or capital, not relevant goods, so they do not move the needle. The result is that most service businesses on FRS are Limited Cost Traders most of the time, whether they realise it or not.

This is the structural reason why FRS lost most of its appeal for service businesses after 2017. The scheme was originally tuned to give a modest gain to small service businesses on rates such as 14.5 percent. Once the LCT rule forces the rate up to 16.5 percent, that gain disappears and there is no economic reason to stay on FRS.

Worked example: a remote consultancy on LCT

A solo consultancy expects £120,000 of net turnover and £24,000 of output VAT in a year, so VAT-inclusive turnover is £144,000. Its main costs are a laptop (capital, excluded from the test), cloud software (services, excluded), professional fees (services, excluded) and a small amount of office stationery. Relevant goods spend totals around £200 a year, well under the £1,000 floor and easily under the 2 percent threshold.

The business is a Limited Cost Trader. At 16.5 percent, FRS payable is £23,760, against £24,000 of output VAT charged. The FRS gain before considering input VAT is £240 a year. Under standard accounting the same business would charge £24,000 of output VAT and reclaim, say, £1,500 of input VAT on standard-rated expenses, leaving £22,500 payable. Standard accounting beats LCT-FRS by roughly £1,260 a year, plus removes the period-by-period LCT calculation from the to-do list.

The period-by-period mechanics

Goods bought to game the test

HMRC built in specific exclusions to stop the obvious gaming routes. Goods bought purely to lift the relevant goods total above the 2 percent threshold, such as low-value items disposed of cheaply or given away, are caught by the rules on goods bought for resale at a loss or for marketing giveaways. Items that have no genuine business use are not wholly and exclusively for business and fall out of the definition. Fuel for road vehicles is specifically excluded outside the genuine transport sector, which closes another common workaround. The practical point is that there is no clean way to spend money on goods purely to pass the test; the rules anticipate the obvious moves.

Side-by-side: LCT versus standard accounting

What to do if you are a Limited Cost Trader

For most service businesses caught by LCT, the right move is to leave FRS and go to standard accounting. The decision is straightforward; the gain on FRS has effectively gone, the admin under standard accounting is well-supported by modern bookkeeping software, and the input VAT recovery on subscriptions, professional fees and capital purchases is meaningful. Leaving FRS is done by writing to HMRC at the end of any VAT period, with the business reverting to standard accounting from the following period.

When to stay on FRS despite LCT

There are limited cases where staying on FRS with the LCT rate still makes sense. A business that is barely above the deregistration threshold and expects to leave VAT soon may prefer the simpler admin for the short remaining period. A business in its first year of registration that has the 1 percent discount might find that the temporary effective 15.5 percent rate, combined with very low expense VAT, still leaves a tiny gain over the cost of standard accounting. These are minority cases; the default answer for an LCT business is to move to standard accounting.

Common mistakes around the LCT test

• Counting software subscriptions as relevant goods; they are services and do not count.
• Counting capital purchases as relevant goods; they are excluded from the test.
• Counting fuel outside the genuine transport sector.
• Applying the test annually rather than per VAT period.
• Assuming a single period of borderline spend keeps the business out of LCT for the year.
• Buying low-value goods purely to pass the test, which falls foul of the resale-at-a-loss and marketing exclusions.

Key takeaways on the Limited Cost Trader test

The Limited Cost Trader test is a mechanical, period-by-period assessment that pushes most service businesses onto the 16.5 percent flat rate, leaving only about 0.4 percent of FRS gain on each pound of turnover. For the typical small service business, that gain is wiped out by lost input VAT recovery on subscriptions, professional fees and capital purchases. The honest answer for most LCT-classified businesses in 2026 is to leave FRS and use standard accounting, with a specialist VAT accountant confirming the timing and handling the HMRC notification.