The Flat Rate Scheme for VAT

The Flat Rate for VAT Scheme was introduced by the Government to simplify the VAT rules for small businesses. If you have reasonable grounds to believe the value of your business’s taxable supplies in the next 12 months will be less than £150,000 (exclusive of VAT), your company is eligible to account for VAT using the flat rate scheme.

All invoices under the flat rate scheme continue to be raised with VAT charged at the appropriate rate, but the way in which a business accounts for VAT to HMRC changes. Instead of working out your output against your input VAT on a quarterly return you select from a list published by HMRC, a percentage based upon the category of business into which your company’s activity falls. This percentage is then applied to the company’s VAT inclusive turnover. This value is what the business accounts for to HMRC in each VAT quarter.

Your business invoices and receives VAT at the standard rate but pays VAT calculated at its flat rate percentage to HMRC. A business in its first year of VAT registration is allowed an additional 1% reduction on its percentage rate lasting for one year from the VAT effective date.

However, from 1ST April 2017, we explain the changes that will make the adoption of the flat rate scheme less attractive and therefore the standard rate VAT scheme more appropriate for your business.

The New ‘Limited Cost Traders’ Flat Rate VAT Percentage – Changes from 1ST April 2017

The Government believes that some trades have unfairly benefited from using the Flat Rate Scheme, particularly small businesses with low costs (such as contractors), and hopes that a change to the way the Flat Rate Scheme is calculated “will help level the playing field, while maintaining the accounting simplification for the small businesses that use the scheme as intended.”

As announced in The Autumn budget, from 1st April 2017, so-called ‘limited cost traders’ will use a new 16.5% rate when calculating their FRS liabilities. All other businesses will continue to use the current percentages used by HMRC.

So, limited company contractors who meet the definition of limited cost traders will be obliged to pay more in additional VAT liabilities in the year.

According to the HMRC technical note, a Limited cost trader will be defined as one whose VAT inclusive expenditure on goods is either:

  • less than 2% of their VAT inclusive turnover in a prescribed accounting period.
  • greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1000).

To prevent businesses including everyday purchases, such as goods, to increase their costs above the 2% threshold, for the purposes of this measure, goods must be used exclusively for the purpose of the business. However, this excludes the following items:

  • Capital expenditure- e.g. laptops, printers
  • Food or drink for consumption by the Flat Rate business or its employees
  • Vehicles, vehicle parts and fuel (except where the business is one that carries out transport services - for example a taxi business - and uses its own or a leased vehicle to carry out those services)
  • Excludes printer ink /stationery which you could personally benefit from
  • Includes goods acquired to give away or donate.

Anti- forestalling legislation was also introduced to prevent businesses invoicing in advance or taking other measures to avoid meeting the Government’s definition of a limited cost trader.

HMRC has announced an eight-week consultation period from the 5th December 2016 – for most businesses, it will be obvious if they meet the criteria of a limited cost trader and there will be also be an online tool which will enable businesses to work out whether they should use the new 16.5% rate or not.

For our existing clients, it may be financially beneficial to consider using the standard VAT scheme after 1st April 2017.

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