This site uses cookies to improve your browsing experience and analyse use of our website. By clicking ‘I accept’ you agree and consent to our use of cookies. You can find out more about our cookies here. Find out more

VAT flat rate scheme changes worth careful consideration

Tim Woodgates, Paul Nash

For VAT registered business with taxable turnover of under £150,000, there has long been the option of using the VAT Flat Rate Scheme (FRS).

The scheme allows businesses the opportunity to use a simplified way of calculating their VAT liability rather than using the standard method of deducting input VAT incurred on purchases from output VAT charged on their sales.  The scheme works by simply applying a flat rate percentage to the gross turnover of a business to determine the VAT payable.

The percentage applied depends on the business sector and is calculated by HMRC to approximately result in the same amount of VAT payable by the business had the standard regime been in place.

This has been an attractive option for many smaller businesses as it simplifies the application of the VAT regime, allowing the trader to focus on growing the business.  However there are instances where the application of the Flat Rate Scheme has resulted in VAT savings for the business - something HMRC wants to prevent.

What do the changes mean?
In the Autumn Statement 2016 it was announced that a new VAT rate of 16.5% will apply from 1 April 2017 to what is termed “limited cost traders”.  A limited cost trader is defined as one that spends less than 2% of its sales (or less than £1,000 in total irrespective of their sales level) on goods.  “Goods” does not include costs for services and also excludes payments for capital items, food and drink and costs of relating to motor vehicles such as fuel and repairs. 

This will affect businesses which are labour intensive and characteristically provide services which do not typically incur significant costs for goods.  The most likely affected sectors are: 
  • Consultancy services
  • IT contractors
  • Hairdressers and beauticians
  • Professional services (legal, accountancy, bookkeeping, etc.)
  • Labour only construction work
HMRC has introduced the changes to tackle ‘aggressive abuse’ of the Flat Rate Scheme and admits that the new rate will “remove the cash advantage for those businesses with limited costs” – affecting all businesses and not just those supposedly using the scheme to avoid tax.

For those business affected by these changes it will mean an increase in the VAT payable from 1 April 2017.  There are also anti-forestalling provisions in place to prevent invoicing in advance to escape the higher rates. Overall, HMRC anticipates that the changes will result in an additional £130m of tax being paid by small business owners.

An added burden for businesses is the requirement to review costs on a quarterly basis to ensure the legislation is being complied with.

The limited credit for input tax with the 16.5% FRS rate means an estimated 4,000 existing FRS users will probably be better off reverting to normal VAT accounting – i.e. output tax less input tax.

“Limited cost trader” under FRS - £1,200 (gross turnover) x 16.5% = £198 VAT payable
Standard VAT regime - £1,000 (net turnover) x 20% = £200 VAT payable    
When looking at numbers, 16.5% of gross turnover is only marginally beneficial to 20% of the net turnover under the standard VAT regime before taking into account the VAT inputs that would have been deductible.

At the moment around two thirds of those using the Flat Rate Scheme are registered for VAT on a voluntary basis (annual taxable sales are less than £83,000), so for many deregistering may be the best option.  HMRC itself quotes average cost savings of around £390 for businesses who deregister post 1 April 2017.

It is important for businesses using or considering the use of the Flat Rate Scheme factor these changes into their decision.  The simplification benefits of the Flat Rate Scheme must be weighed carefully against the potential increase in VAT costs.  For some, the application of the standard VAT regime, notwithstanding its administrative burden, may be the best decision commercially for the business.

If you have any VAT queries or would like advice on any aspect of your taxes, please contact your usual Moore representative.