VAT flat rate scheme changes

The Chancellor announced in the Autumn Statement 2016, that with effect from 1 April 2017 a new ‘flat rate’ of 16.5% VAT will be introduced for business with ‘limited costs’, the aim of which is to address possible abuse of the existing flat rate scheme.

What is the flat rate scheme?

The flat rate scheme was introduced in 2002 as an accounting scheme by which small businesses could simplify the complexities of VAT. Instead of standard VAT accounting i.e. where businesses charge 20% VAT on standard rated sales and reclaim VAT incurred on their business purchases, the flat rate scheme sought to simplify this by allowing businesses to account for VAT at a lower rate, (albeit VAT would still be charged at the standard rate on invoices) with the difference between the two rates acting as a ‘proxy’ for input tax deduction on purchases.

The rate by which businesses using the flat rate scheme account for VAT depends upon the industry in which they operate, with rates ranging from 4% to 14.5%.

What’s changing?

To address perceived abuse of the scheme, from 1 April 2017, in addition to determining the percentage range relevant to their sector as above, businesses will also need to determine whether they fit the criteria of a ‘limited cost trader’ and if they do, will need to use the higher rate of 16.5%.

What is a Limited Cost Trader?

A limited cost trader is a business whose VAT inclusive expenditure on goods is either:

  • less than 2% of their VAT inclusive turnover in a prescribed accounting period; or
  • greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).

Goods, for the purpose of this measure, must be used exclusively for the purpose of the business but exclude the following items (to prevent businesses inflating their costs):

  • capital expenditure.
  • food or drink for consumption by the flat rate business or its employees.
  • vehicles, vehicle parts and fuel (except where the business is one that carries out transport services - for example a taxi business - and uses its own or a leased vehicle to carry out those services).

Anti-forestalling provisions

Paying or invoicing in advance to avoid an increase in tax is known as forestalling. Legislation to prevent this has been introduced relating to transactions occurring between 24 November 2016 and 31 March 2017. The provisions are designed to prevent any business that now meets the definition of a limited cost trader from continuing to use a lower flat rate beyond 1 April 2017.

As a result of the legislation, any business that supplies a service on or after 1 April 2017 but either issues an invoice or receives a payment for that supply before 1 April 2017, then those services will be deemed to have taken place on 1 April 2017.

Impact

HMRC believe this will generate on average £115m a year of additional VAT received from an estimated 4,000 businesses that may switch to the more cost effective standard VAT accounting. Interestingly, HMRC state that two thirds of the flat rate scheme are below the compulsory VAT registration threshold and expects a number to de-register as a result of the introduction of the limited cost trader percentage.

Next steps for businesses

We would urge businesses to undertake the tests outlined above to identify whether they are impacted by this change to the flat rate scheme. It should be noted that the limited costs only cover ‘goods’, and therefore businesses that buy in services may be unfairly disadvantaged and may wish to consider switching to standard VAT accounting.

Please speak to Alison Birch or Tim Adcock for further advice.

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