Flat Rate Scheme Changes
In The Autumn Statement the Chancellor announced changes to the existing VAT Flat Rate Scheme (FRS - introduced in 2002) to tackle what the Government perceives as abusive behaviour by businesses.
Flat Rate Scheme: What are the changes?
From 1 April 2017 HMRC will introduce a new category of trader - known as a ‘limited cost trader’ - which will have a Flat Rate Scheme percentage of 16.5%.
Who will be regarded as a limited cost trader?
You will be treated as a limited cost trader if your VAT inclusive expenditure on goods is:
- Less than 2% of your VAT inclusive turnover; or
- More than 2% of your VAT inclusive turnover though less than £1,000 per year
What are goods as far as the new rules are concerned?
Goods are anything used exclusively for business purposes except:
- Capital expenditure. So for example you won't be able to purchase a new computer in order to circumnavigate the 2% rule detailed above.
- Food and drink for consumption by you as the business owner or your employees. This is consistent with the existing rules whereby VAT recovery is blocked on business entertaining expenditure.
- Vehicles, vehicle parts and fuel, unless your business is one which supplies transport services for example a taxi business. In any event VAT recovery on the purchase of a car, or repairs is blocked/restricted for a number of existing businesses.
- Goods for resale, leasing, letting or hiring out if your main business activity doesn’t ordinarily consist of selling, leasing, letting or hiring out such goods
- Goods that you intend to re-sell or hire out, unless selling or hiring is your main business activity
- Any services
HMRC have given the below examples of relevant goods however be aware that this is not an exhaustive list:
• stationery and other office supplies to be used exclusively for the business
• gas and electricity used exclusively for your business
• fuel for a taxi owned by a taxi firm
• stock for a shop
• cleaning products to be used exclusively for the business
• hair products to use to provide hairdressing services
• standard software, provided on a disk
HMRC have also given the below examples of items that are NOT relevant goods:
• accountancy fees, these are services
• advertising costs, these are services
• an item leased/hired to your business, this counts as services, as ownership will never transfer to your business
• food and drink for you or your staff, these are excluded goods
• fuel for a car this is excluded unless operating in the transport sector using your own, or a leased vehicle
• laptop or mobile phone for use by the business, this is excluded as it is capital expenditure
• anything provided electronically, for example a downloaded magazine, these are services
• rent, this is a service
• software you download, this is a service
• software designed specifically for you (bespoke software), this is a service even if it is not supplied electronically
You can more about this here. The examples mentioned above are in section 4.5 and 4.6.
Who are these measures aimed at?
The new rules are aimed at making the Flat Rate Scheme far less attractive for service-related businesses such as IT consultants or accountants(!) who incur VAT on services such as rent, software licences, telecoms and so on but not on physical goods.
What action do I need to take?
Going forward for each VAT accounting period, you will need to consider whether your business is a limited cost trader. If you are a limited cost trader, then your Flat Rate Scheme percentage will be 16.5% regardless of what business sector you operate in.
HMRC have promised to introduce an 'easy-to-use online tool' to help business owners determine whether they are a 'limited cost trader' and whether they should apply the rate of 16.5%. However given the unreliability of HMRC's online services (e.g. their Government Gateway for new PAYE schemes) we are sceptical as to how well this will work in practice.
Are there any other changes I need to be aware of?
HMRC have introduced measures which take immediate effect where a business tries to reduce their post 1 April 2017 turnover by issuing invoices early.
When do these measures apply?
For most businesses, the new rules will apply for any invoices raised after 1st April 2017 which relate to services supplied after 1st April 2017.
However beware if you issue an invoice or receive a payment before 1st April 2017 which relates to services supplied after 1st April 2017. If this applies to you then, for the purposes of considering whether the limited cost trader definition is met, your VATable supply will be treated as being made on 1st April 2017.
Where your services are performed during a period which spans 1st April 2017, an apportionment must be made on a fair and reasonable basis when applying the new flat rate percentage.
You will also need to make adjustments to your VAT turnover if you issue an invoice or receive payment after 23rd November 2016 (the date these measures take effect) and before 1st April 2017 which relate to services performed on or after 1st April 2017.
Given that the Flat Rate Scheme has been in force for a number of years, these changes are effectively bolting the proverbial stable door after the horse has left. The Flat Rate Scheme was originally introduced with the intention of simplifying accounting for VAT and to encourage small businesses to comply. Many small business owners who are still reeling from the effect of the new dividend tax must feel particularly aggrieved by these changes. The anticipated tax yield is relatively modest and once again the Government appears to be tinkering around the edges and hitting small businesses rather than tackling head on the wide scale tax avoidance carried out by the multi-nationals.
Historically it may be that you have been better off using the Flat Rate Scheme so from 1 April 2017, when you have to apply the higher percentage of 16.5%, you may be better off exiting the scheme and calculating VAT due to HMRC as normal. You will also have to consider whether the administrative advantages of remaining within the scheme outweigh the additional cost.
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