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The government is about to gut the VAT Flat Rate Scheme

  1. VAT Flat Rate Scheme
    Christian Annesley

    Christian Annesley Contributor Full Member

    Posts: 3 Likes: 1
    8 |

    Using the VAT Flat Rate Scheme? It’s urgent that you understand the government’s planned changes from 1 April 2017.

    Many contractors, micro-business consultancies and other small outfits will be affected by the government’s planned changes to the VAT Flat Rate Scheme, which were signalled last autumn without fanfare and are being brought in for April 2017.

    The cash benefit offered by the flat-rate scheme has provided a lifeline to many small operations, as well as simplifying VAT treatment. What is there to know and understand about the scheme and its de facto removal for many?

    What is the Flat Rate Scheme (FRS) for VAT?

    The FRS is used by hundreds of thousands of small businesses to simplify VAT reporting. Lots of those businesses also gain a cash advantage from using the scheme, but this advantage is due to be cut back significantly from 1 April 2017. The FRS will continue but many businesses will not find it economical to use.

    How does it work now?

    When using the FRS the business ignores VAT incurred on purchases when reporting VAT payable, with the exception of capital items that cost £2,000 or more. The trader simply multiples gross turnover (including VAT charged at the normal rates) by the FRS percentage set for the relevant trade sector.

    This FRS percentage is supposed to take account of the amount of VAT likely to be incurred on business expenses. The common percentages used by service-related businesses are:

    • Journalism or entertaining 12.5%
    • Accountancy and legal services 14.5%
    • Computer or IT consultancy 14.5%
    • Business services not listed elsewhere 12%
    • Estate agents and property management 12%
    • Management consultancy 14%

    What this means is that service businesses with few expenses, and that operate in a sector with a relatively low FRS percentage, pay out less VAT to HMRC than they would outside the scheme. Many businesses register for VAT voluntarily before turnover reaches the VAT registration threshold, so they can use the FRS and bank the cash advantage.

    Here’s an example. A business services company invoices a client £1,000 plus VAT at 20%. So £1,200 in all. When it comes to passing the VAT charged to the government the FRS calculation is 12% of the gross billing of £1,200 – £144 in this case. The business can bank the difference of £56.

    Why is it changing?

    The government believes small businesses have been abusing the FRS – particularly recruitment businesses setting up multiple companies to use the scheme.

    The Guardian exposed the abuse in a piece last year and the government reacted by changing the rules and talking about the “aggressive abuse” of the scheme.

    Unfortunately, the government has tarred all small businesses using the scheme by extension, despite most using it as the law intended. In any case, the government is now changing the terms of the scheme to make is less attractive and to reduce the cash advantage enjoyed by service-related businesses.

    How will it work from 1 April 2017?

    From 1 April 2017, a business will be required to use a FRS percentage of 16.5% if it is a “low cost trader” (see below). This is likely to adversely affect businesses in all of the trade sectors listed above and possibly many other similar businesses as 16.5% of the gross turnover is equivalent to 19.8% of the net leaving almost no credit for VAT incurred on purchases. It means the scheme is not viable for most services businesses that use it and most will be better off leaving the scheme if they turnover under the VAT threshold of £83,000.

    What is a low cost trader?

    A low cost trader, in the government’s newly minted definition for the FRS, is a business with expenditure on goods (not services) of less than 2% of its gross turnover or, if more than 2% of its turnover, where the amount spent on goods is less than £1,000 per year. Any expenditure on capital items, motor expenses or food and drink for consumption by the business is ignored when working out the 2% or £1,000 threshold.

    This emphasis on goods discriminates against businesses that incur VAT on services such as rent, software licences, IT support, digital journals, sub-contractors, telecoms and so on. In VAT terms, a service is anything that is intangible or where the cost relates to a tangible asset it is the temporary use of that asset – such as hiring.

    What happens next?

    The government hasn’t provided a great deal of clarity to help businesses in deciding whether to remain in the FRS.  For some, it will be unclear what goods or services are included in the expenses – but every affected individual need to try to calculate the impact and decide on his or her status.

    There is also further work to be done by the government to clarify the handling of dates and invoices in relation to accounting periods and the roll-out of the new scheme on 1 April 2017. We’ll keep you in the picture in the weeks ahead.

  2. websensejim

    websensejim UKBF Contributor Full Member

    Posts: 62 Likes: 15
    Thanks for the heads up and in-depth article, Christian.

    Sadly its another example of the government punishing small businesses who are the lifeblood of the economy.
    Posted: Feb 28, 2017 By: websensejim Member since: Jul 22, 2015
  3. Perfect Windows

    Perfect Windows UKBF Regular Full Member

    Posts: 100 Likes: 43
    One rather beautiful detail is that if you have a printer that is used for both business and home, consumables won't count towards the 2%, even if 90% of the usage is business based.

    I foresee a sudden upswing in sales of 99p used inkjet printers from Ebay: "Of course we don't use the main one for personal printing - we have this twenty year old Brother inkjet for personal use".
    Last edited: Mar 3, 2017
    Posted: Mar 3, 2017 By: Perfect Windows Member since: Mar 7, 2011
  4. Ian J

    Ian J Factoring Specialist Full Member - Verified Business

    Posts: 4,005 Likes: 1,094
    Why is it punishing small businesses as the whole idea of the FRS was to simplify the accounting and red tape and not to allow small businesses to make profits out of Vat.

    The new system will still allow for reduced red tape
    Posted: Mar 6, 2017 By: Ian J Member since: Nov 6, 2004
  5. Diesel

    Diesel UKBF Contributor Free Member

    Posts: 70 Likes: 3
    Its punishing small (like really small...) businesses because we will have to work out all receipts and income every time there is a vat return due. If a company has an accounts dept/dedicated staff then that is fine and an ongoing process but for many small businesses they do this in/out admin themselves when they can fit it in around real work or get the accountant to do it annually. On the FRS it was simply a matter of totting up income in and paying the percentage vat due - takes ten mins and we sort everything else out year end. I suspect a £250 spend per quarter on 'goods' will be no issue for us as we are always buying kit (and this is a good excuse to make sure we spend on the 'toys' :)) but there was always a reason that we don't want the hassle of full on vat returns every quarter and wanted to focus on running the actual business in a way that suits us - not HMRC's admin...
    Posted: Mar 10, 2017 By: Diesel Member since: Apr 8, 2008
  6. webgeek

    webgeek UKBF Big Shot Full Member - Verified Business

    Posts: 3,637 Likes: 1,355
    Great article, thank you!

    Wouldn't this change encourage small UK firms to not early enrol for VAT, thus not charging VAT, and then make purchases from international companies where they're not charged sales tax (in the case of American firms)?

    Seems like the incentive is to buy-American services, a strange message from the UK government indeed.
    Posted: Mar 10, 2017 By: webgeek Member since: May 19, 2009
    ChrisGoodfellow likes this.
  7. Talay

    Talay UKBF Big Shot Free Member

    Posts: 3,655 Likes: 775
    I view it as a stepping stone to regular VAT and quite honestly, I think the VAT threshold should be far higher, say around £250k.

    If you are selling into other VAT registered businesses, then it matters not a jot as you can "add" the VAT to the invoice and the client won't bat an eyelid.

    However if you are selling a service to the tune of a whopping £1500 a week, then your pricing and crucially, the pricing of most other suppliers, will be VAT "free". Adding 20% to your invoices when your competitor doesn't have to add it to theirs is going to lose you business in the B2C sector.

    Flat rate VAT offers you a void up to £230k or so whereby you "make" a little back if you have low inputs or a high labour content.

    I could also argue that everything should have VAT on it and from zero turnover but that simplification of the system is about as likely as ditching national insurance and just having a single tax rate.

    The awkward truth is that many small businesses are only profitable when they don't charge VAT as their original calculations didn't include the VAT element. My advice as always is to think of the first £90k or so as a VAT rebate to help out, so that mentally at least, VAT is already included in the price charged.
    Posted: Mar 10, 2017 By: Talay Member since: Mar 12, 2012
  8. Talay

    Talay UKBF Big Shot Free Member

    Posts: 3,655 Likes: 775
    Any service firm with few inputs would be mad to charge VAT from day one. You are throwing away 20% of £90k minus your few incidentals and as you can include items from before your registration, you can cover a lot that you pay out in VAT after you register.
    Posted: Mar 10, 2017 By: Talay Member since: Mar 12, 2012
  9. webgeek

    webgeek UKBF Big Shot Full Member - Verified Business

    Posts: 3,637 Likes: 1,355
    @Talay - no you're not throwing anything away.

    If you're a service firm and charge your clients X price + Y vat, you still get your entire X price from the clients.

    However, under flat rate vat scheme, you get to keep a fixed percentage. It might be 9% of the 20% or 11% of the 20%. It's free money that goes straight into your company profit column.

    So, you're receiving X * 109% or X * 111%.

    Flat rat vat was a big boon to service companies who were able to cash in and make a nice chunk of extra money, all for just collecting and passing on an almost equal share of VAT to the government.

    I made thousands of Pounds that I wouldn't have otherwise, thanks to the old flat rate VAT scheme.

    Besides - clients expect you to charge VAT if you're a "real" business and not a flybynight.
    Posted: Mar 22, 2017 By: webgeek Member since: May 19, 2009