VAT flat rate scheme changes
On 1 April 2017 a new ‘flat rate’ of 16.5% VAT was 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%.
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 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).
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.
Action for businesses
Businesses need 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.
For further advice please contact a member of our team below.