Changes to the VAT Flat Rate Scheme

by M Tombs
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In a surprise announcement in the 2016 Autumn Statement, the Chancellor announced that changes are to be made to the existing flat rate scheme for VAT (FRS) in order to tackle perceived ‘aggressive abuse’. The changes, which will take effect from 1 April 2017, are designed to ‘reduce the incentive for firms and agencies to move employees to self-employment to exploit VAT simplification aimed at small businesses’. The subsequent HMRC policy paper published on 5 December sets out the details of the changes, which will affect any users, or prospective users, of the FRS.

The FRS is a simplified VAT accounting scheme for small businesses, which currently allows users to calculate VAT using a flat rate percentage by reference to their particular trade sector. From 1 April 2017 a new 16.5% FRS rate will be introduced for businesses with limited costs. Interestingly, HMRC’s policy paper on this change comments that ‘many labour only businesses’ may be affected. Although not yet clarified, this may mean the adjustments will not apply to service-related businesses such as journalists, architects or engineers.

Between now and 1 April 2017, anyone currently using the FRS for VAT, or thinking of joining the scheme, will need to decide whether they are a ‘limited cost’ business. For some businesses – for example, those who purchase no goods, or who make significant purchases of goods – this will be obvious. Other businesses will need to complete a simple test, using information they already hold, to work out whether they should use the new 16.5% rate.

A ‘limited cost’ business is defined in the draft legislation 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 £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).

Goods, for the purposes of this measure, must be used exclusively for the purpose of the business but exclude the following items:

  • capital expenditure goods;
  • 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).

These exclusions are part of the test to prevent traders buying either low value everyday items or one off purchases in order to inflate their costs beyond 2%.

To support businesses implement this change, HMRC have said that they will be launching an online tool that will enable both current and prospective users of the FRS to determine whether they must use the new rate.

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  • February 8, 2017

    Is this something that TLA can advise on, based on previous accounts? In other words, for flat rate businesses, you let us know if you think we might have an issue regarding this change. Just a thought…..

    • February 8, 2017

      Yes. For all our clients where we either produce or review VAT returns quarterly we have already made recommendations. One clear trend is that all of the service businesses we deal with are better off changing from the flat-rate scheme to the normal scheme. Because it is only goods (excluding fixed assets) not services or intangibles, such businesses typically spend very little on costs that would be allowed in the calculations.

      Taking our business as an example (although we aren’t on the flat rate scheme anyway) because the bulk of our costs are payroll (including sub-contracted staff), travel, software, subscriptions, hosted IT services, office rental and telephony, the remaining costs we could take into account are below the 2% level (largely printer cartridges, printing and stationery!) even though costs on which we pay VAT are a long way above that level. The new rules seem to be particularly harsh for service businesses.

      What we haven’t done and should have, is to talk to those clients of ours on the flat rate scheme where we don’t get involved in the quarterly returns. Time to hit the phones…….