Changes to the Flat Rate VAT Scheme

Background 

'Normal' VAT traders have to account to HMRC for one-sixth of their VAT-inclusive turnover from standard-rated supplies and nothing on zero-rated or exempt supplies. They also claim back the VAT that they paid to suppliers on expenses, as long as those expenses are used to make taxable (standard, lower or zero-rated) supplies.

As this is complicated, the Flat Rate Scheme was introduced for small traders as a simplification. No input tax is reclaimed and whilst VAT was still charged at the standard rate not all of this was paid to HMRC, some is retained to compensate for the loss of reclaim of input tax. For example, some businesses currently apply a flat rate of 12% to gross income. If gross income is all standard-rated, someone with net turnover of £100,000 collects £20,000 in output tax and accounts for only £14,400 of it to HMRC (12% x £120,000). The input tax 'compensation' of £5,600 represents the equivalent of £28,000 of net VATable inputs and most of those who have joined it only did so after working out that they will benefit financially from doing so.

What is changing? 

As of 1st April 2017 if your business is registered for the flat rate scheme you will need to determine if you fall under the new rules announced by Chancellor Philip Hammond in the Autumn Statement, which affect businesses with a low cost base. These businesses are now called "limited cost traders" and are subject to a new flat rate percentage of 16.5%, regardless of the company’s activity. 

Limited cost trader – A business who spends less than 2% of VAT inclusive turnover in an accounting period on goods or alternatively greater than 2% but less than £1,000. HMRC define goods as items that are exclusively for the purpose of business. This does not include, motor and travel, accountancy, legal fees, software, advertising, capital expenditure, subsistence, or any expense that has an element of private use. 

Simply

 

Conditions Limited Cost Trader Not a Limited Cost Trader

 

Less than 2% of VAT inclusive turnover is spent on goods.

 

a

 

 

More than 2% of VAT inclusive turnover is spent on goods and this equates to more than £1,000.

 

 

a

 

More than 2% of VAT Inclusive turnover is spent on goods and this equates to less than £1,000.

 

a

 

The new legislation may mean it could be more beneficial for you to switch to the normal VAT system or even de-register from VAT, depending on your individual circumstances. 

Who will this affect? 

It will increase the VAT paid by labour-intensive businesses where very little is spent on goods. For example, this may affect IT contractors, consultants, hairdressers and others who sell their own services. It will also affect construction workers who supply their labour, but where the raw materials are provided by the main contractor.

If you would like us to quantify the effect of this on your business please contact us on 0845 330 3200