two-fingers-to-vat

There was very little in the 2016 Autumn Statement which directly affected small business, but one measure caught our eye; HMRC are changing the VAT Flat Rate Scheme.

The VAT Flat Rate Scheme is a simplified scheme for accounting for VAT.  If you are VAT registered and on the scheme, you forego the ability to reclaim input VAT on your costs.  Instead, you account for VAT on your gross sales, at a predefined percentage which is dependent upon your business type.

For example, a consultant may use a rate of 14.5%.  Therefore, if they issue an invoice for £1,000 plus VAT (= £1,200), they will account for VAT of 14.5% on £1,200 = £174.  The difference in VAT between what they charge (£200) and what they pay over to HMRC (£174) is supposed to represent the loss of input VAT which they can reclaim.

This element of the scheme has made it popular, as it has reduced the need to split out input VAT on purchases, which can be time consuming and difficult.

However, this is changing.

With effect from 1 April 2017, the change affects businesses with a very low cost base. These businesses are called “limited cost traders”.  They can still use the Flat Rate Scheme, but their percentage will be 16.5%, so in the example above, the VAT they will pay over is £198.

What is a limited cost trader?

A business is a limited cost trader if its VAT inclusive expenditure on goods is:

Goods are those used exclusively for business purposes, excluding:

HMRC have introduced anti-forestalling measures to prevent businesses from reducing their post April 2017 turnover by issuing invoices early. If a business supplies a service on or after 1 April 2017, but issues an invoice or receives payment before 1 April 2017, then those supplies are treated as being made on 1 April 2017 for the purposes of considering whether the limited cost trade definition is met. More information in respect of the anti-forestalling measures can be found in the updated VAT Flat Rate Scheme guidance (sections 8.2 and 9.7).

Draft legislation will be published on 5 December 2016 for an 8 week period of consultation.  HMRC have promised businesses an ‘Easy-to-use online tool’ to help them work out whether or not they are limited cost traders and should use the new rate of 16.5%.

Comment

HMRC have taken a simplification process and made it more complicated! It now offers very little incentive to use the Flat Rate Scheme if you are a service business, as you would presumably be better off operating VAT under the normal method and reclaiming input VAT on your costs. It would probably have been easier to raise the Flat Rate Scheme percentages all round – or perhaps that will happen next year!

 

VAT!

The intention of the Flat Rate Scheme is to simplify the process of reporting VAT for businesses.  VAT payable becomes simply a factor of VAT inclusive sales for a quarter – removing the need to analyse input VAT on purchases.  See here for our recent blog on the Flat Rate Scheme.

There is also an opportunity to make money by using the Flat Rate Scheme.  This centres around small service companies, but could be considered for other businesses.

Say Mike has a management consultancy which registers for the Flat Rate Scheme.  In the first quarter, he invoices £10,000 + VAT = £12,000.  The Flat Rate Scheme rate for management consultancy businesses is 14.0%. Thus, the VAT he pays over to HMRC is £12,000 x 14% = £1,680.

Therefore, he charges his customer £2,000, but only pays over £1,680, giving him a profit of £320.  Simply for being VAT registered.  Essentially, this is to compensate for not reclaiming any input VAT.  However, for a service business, any input VAT would be minimal.

This is a very simple example, but it illustrates the potential upside.

Note: in our view, we believe that it is imperative that you take professional advice before registering for VAT and/or the Flat Rate Scheme.

VAT!

For years, many small businesses have stated that being registered for VAT is an administrative burden on their business.  By being VAT registered, a business is effectively an unpaid tax collector.  In order to try and help small businesses, the Flat Rate Scheme (FRS) was introduced by HM Revenue and Customs (HMRC) in 2002.

If you are VAT registered, the usual way of accounting for your VAT is to calculate how much you have charged your customers, which you need to pay over to HMRC, and how much VAT you have incurred on your purchases, which can be deducted from the amount you have to pay over.

The main way in which the FRS tries to help business is by removing the need to separate input VAT from expenses, which can take a lot of time and effort.  Instead, the VAT liability of a business is calculated using a pre-determined % (based on the industry in which the business operates), which is applied to the gross amount charged to customers.

For example, Helen is an IT consultant.  If she registers under the FRS, she still charges her clients standard rated VAT.  So a bill for £1,000 has £200 VAT added on.

Under her sector, the relevant % is 14.5%.  Therefore, the total VAT liability is £1,200 x 14.5% = £174.

So although she charges her client £200, she only has to pay £174 over.  The balance effectively represents an estimate by HMRC of the input VAT that she cannot reclaim.

Obviously one of the biggest advantages of operating the FRS is that it dramatically simplifies the VAT process, plus removes some of the ambiguity of whether input VAT can be reclaimed on smaller receipts.  However, it does not remove the need for normal bookkeeping requirements.

Although you cannot reclaim any input VAT, there is a provision for reclaiming input VAT on capital assets with a VAT-inclusive cost of at least £2,000.

The full details of the FRS can be found here:

http://www.hmrc.gov.uk/vat/start/schemes/flat-rate.htm