Small businesses using the VAT Flat Rate Scheme, who have low costs, may see the rate they pay drastically increase under new changes which came into effect at the beginning of this month.
The Flat Rate Scheme was created to simplify businesses’ record keeping, by making it easier for smaller companies to calculate their bill.
VAT is usually calculated using a two-stage process, whereby VAT registered businesses are required to deduct the VAT on their inputs from their outputs. Meanwhile, the Flat Rate Scheme uses a simplified single step process, meaning businesses only pay VAT on the sale at a rate dependent upon their business type.
Whilst this system is simpler for small businesses it can also result in businesses effectively paying more or less than they would do under the ‘typical’ two-stage VAT regime.
HM Revenue & Customs has been aware of this inconsistency for some time and has long suspected some businesses of using the rules to their advantage.
With this in mind the Chancellor, Philip Hammond, announced changes to the Scheme at the last Autumn Statement, in November 2016, which now see the rates applicable to low cost businesses, referred to as ‘limited cost traders’, increase.
Limited cost traders are one of the groups accused of unfairly benefiting from the system. They can still use the Flat Rate Scheme, but their percentage now increases to 16.5 per cent adding hundreds, if not thousands, to their FRS liabilities.
Businesses that spend less than two per cent of sales on goods (not services) in an accounting period are considered limited cost traders. A business is also considered a limited cost trader if it spends less than £1,000 a year, even if this is more than two per cent of the firm’s turnover on goods.
If your return is less than one year, the figure is the relevant proportion of £1000. For a quarterly return this is £250.
For example, A business has a flat rate turnover of £20,000 a quarter. It spends £325 on relevant goods. This is more than £250 but less than 2% of the flat rate turnover so the rate they need to use is 16.5%.
When working out the amount spent on goods, firms cannot include purchases of capital goods, food and drink, vehicles, parts for vehicles or fuel.
IT contractors, consultants and hairdressers, which heavily rely on labour, with very little other cost, are examples of businesses likely to be affected. Construction workers who supply their labour, but are provided with the raw materials by the main contractor, are also likely to be caught up in the new changes.
The new rules came into effect on 1 April 2017.
VAT is a complex area and you must give thought to whether you are applying the rules and regulations correctly. When it comes to the FRS you should consider whether it is more beneficial to remain in scheme, or otherwise revert to standard accounting. As with any tax there is plenty of opportunity for planning to minimise your liability and our experts can assist you with this, ensuring that you are compliant at all times and making sure you avoid any potentially costly mistakes.
To find out more about how we can help you, take a look at our taxation services.