Vat Flat rate scheme may no longer be worthwhile

This will affect businesses that use the VAT Flat Rate Scheme but which spend very little on goods, including raw materials - such as firms providing services. These businesses are now called "limited cost traders".

The VAT Flat Rate Scheme simplifies businesses' record keeping, and makes it easy to work out the VAT they have to pay.

 

How does it work?

Normally a business deducts the VAT on its inputs (what they buy) from the VAT charged on what they sell (outputs).

Under the Flat Rate Scheme, that two stage process is simplified to one step.

For example, the flat rate percentage for a clothes shop is 7.5% - so if the owner of that shop sells a dress for £120 including VAT of £20 he will pay a flat rate of £9 (£120 x 7.5%) to HMRC. The flat rate percentage for a detective agency is 12%.

Using the new rate that VAT would be £120 x 16.5% = £19.80

Effectively this allows just £0.20 pence in every £20 vat charged as notional input vat. For some clients the actual input vat on valid invoices would be a bigger amount.

Exactly which sales count can be complicated – the details can be found on the HM Revenue and Customs (HMRC) website at https://www.gov.uk/government/publications/vat-notice-733-flat-rate-scheme-for-small-businesses

The percentages for each type of business vary.

The government claim that the flat rate scheme is designed to give the government roughly the same amount of VAT, but should be much easier to work out. However, very many small businesses will pay much more vat under the flat rate scheme from1st April 2017 and may well be better of reverting to the standard basis.


 

What is changing?

Limited cost traders can still use the Flat Rate Scheme, but their percentage will be 16.5%. So if they sell £120 of work, including £20 of VAT, the flat rate amount is £19.80 (£120 x 16.5%).

A limited cost trader is defined as one that spends less than 2% of its sales on goods (not services) in an accounting period.

When working out the amount spent on goods, it cannot include purchases of:

  • capital goods (such as new equipment used in a business)

  • food and drink (such as lunches for staff)

  • vehicles or parts for vehicles (unless running a vehicle hiring business)

A firm will also be a limited cost trader if it spends less than £1,000 a year, even if this is more than than 2% of the firm's turnover on goods.

Who will this affect?

It will increase the VAT paid by labour-intensive businesses where very little is spent on goods. For example, this may affect IT contractors, consultants, hairdressers and accountancy firms.

It will also affect construction workers who supply their labour, but where the raw materials are provided by the main contractor.

Mike Cherry, national chairman of the Federation of Small Businesses, said: "Many small businesses rely on the optional VAT flat rate scheme to simplify the management of their tax affairs.

"We welcome the government's attempts to clamp down on any misuse of this scheme by a small minority of businesses that use it. However we would be concerned if any small businesses who play by the rules now end up having to pay more to remain within the scheme.

"Following these reforms, it is important HMRC now produces clear guidance so that small firms understand whether or not to join the scheme."

When does this start?

The new rules start on 1 April 2017, but may also affect invoices issued, and goods bought, from now on.

There is more about these "anti-forestalling" rules at sections 8.2 and 9.7 of the newly updated HMRC leaflet on the Flat Rate Scheme at https://www.gov.uk/government/publications/vat-notice-733-flat-rate-scheme-for-small-businesses