Flat Rate VAT and how it is changing
February 28, 2017
From 1 April 2017, the VAT flat rate scheme is being changed to include a new “limited cost trader” definition. If a business is classed as a limited cost trader, it must then use 16.5% for calculating VAT rather than its own industry standard % .
The target market appears to be service businesses, in particular contractors whose main source of expenditure will be travel, telephone, broadband, rental and subsistence costs. Contractors must therefore now prepare themselves to use the higher 16.5% rate for calculating VAT.
For those of you who do not know how it works, here is a brief summary:
- The Flat Rate Scheme (FRS) takes a business’ sales including output VAT (standard rate is 20%) and then multiplies this by the flat rate % to give the VAT figure that needs to be paid to HM Revenue and Customs.
- The business has to decide what flat rate % to use and this can vary from 4% to 14.5%.
- The lower the %, the less VAT to pay and hence the better for the business.
- For businesses with very low costs and which therefore do not suffer much input VAT, using the flat rate VAT scheme used to generate a profit; this has now changed with the introduction of the “limited cost trader” definition: more explanation below
What does the change mean?
Life will definitely get more complicated – so much for the Government’s Office of Tax Simplification!
- A business needs to check its actual spending on “goods” (see explanation below) each quarter. If its VAT inclusive expenditure on “goods” is less than 2% of sales (including VAT) or only £250, then the business must use the new 16.5% rate. If VAT inclusive expenditure on “goods” is above 2% of sales (including VAT) then the business can use its own industry flat rate (e.g. 14.5% for accountant and IT contractors)
- “Goods” exclude vehicles, road fuel and motor parts (unless it is a transport business e.g. taxi firm) as well as food, drink, rent, telephone, internet charges and capital goods. Supplies of gas and electricity are included
- Only goods with 100% business use can be included in the calculation, so an electricity bill with part business and part private use will be excluded completely
- Builders who spend more than 10% of sales (including VAT) on materials in a quarter can use a lower Flat rate of 9.5%. If the material purchases are lower than this, then 14.5% flat rate must be used
- An online tool will enable current and new Flat Rate Scheme users to determine whether they must use the new rate –https://www.tax.service.gov.uk/check-your-vat-flat-rate/vat-return-period
Benefits of Flat Rate VAT Scheme (FRS)
- Simpler VAT returns (except if a business is claiming bad debt relief or operating the VAT Reverse charge -see below)
- No adjustment for any private use element of capital goods input or output VAT (this has to be done under normal VAT accounting)
Disadvantages of FRS
- Complicates VAT returns if claiming bad debt relief or operating the VAT reverse charge as these need to be shown separately on the VAT return -if this applies , the business should use normal VAT accounting
- Input VAT can only be claimed on a capital expenditure item over £2,000 (including VAT) -if a business makes small capital purchases, it is preferable not to be on FRS
- A quarterly review of costs is now needed to see if a business using FRS has to apply the 16.5% rate (limited cost trader) or the industry standard rate (preferable). A way around this is for the business to switch to annual VAT accounting -further information at https://www.gov.uk/vat-annual-accounting-scheme/overview
If you would like to talk more about the changes to the Flat Rate VAT scheme and how it might affect your business please call or drop me an email.