In a state over the new Flat Rate VAT rules?
The Flat Rate scheme is an attractive, simplified VAT accounting scheme applicable to many small limited companies which have low annual costs – however, changes announced in recent Budget Statements mean that from this tax year, changes to the way ‘labour intensive’ businesses calculate their VAT liabilities each quarter are now in place.
Read on to find out how this may affect you…
How does the Flat Rate VAT scheme work now?
Unlike the standard VAT scheme, which requires businesses to calculate their quarterly VAT liabilities by adding up all the VAT charged over a quarter minus all qualifying VATable expenditure, the Flat Rate Scheme (FRS) simplifies these calculations.
Under the FRS, you calculate your VAT liability by applying a fixed-percentage to your gross turnover. The percentage varies according to your trade / profession – for most, this is set at 14.5% but if you are in food manufacturing, for example, it can be as low as 9%. The percentages were essentially chosen to reflect the typical balance between input and output VAT in varying sectors.
Not only is it a simpler system, but there are clear tax advantages. Taking the typical rate of 14.5%, if you invoice a client for £1000 plus 20% VAT, you owe HMRC 14.5% x £1200 = £174 – whereas under the standard VAT scheme, you repay the entire £200 (i.e. 20%) charged on the invoice.
So what’s changing?
The Government believes that some trades have unfairly benefited from FRS, particularly small businesses with low costs such as contractors, and state that a change to the way the FRS is calculated “will help level the playing field, while maintaining the accounting simplification for the small businesses that use the scheme as intended.”
What are the new rules?
From 1st April 2017, so-called ‘limited cost traders’ will use a new 16.5% rate when calculating their FRS liabilities (All other businesses will continue to use the current percentages used by HMRC) What this means in practice is that limited company contractors who meet the definition of limited cost traders will be liable to pay hundreds, if not thousands of pounds in additional VAT liabilities each year.
What is a ‘limited cost trader’?
According to HMRC, this is defined as a business which has a VAT-inclusive expenditure on relevant goods of either:
- less than 2% of their VAT inclusive turnover in a prescribed accounting period
- greater than 2% of their VAT inclusive turnover but less than £1000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is proportional)
To prevent businesses incorporating additional purchases to tip their costs over the 2% threshold, HMRC have ruled that a number of items must be excluded from the calculations, namely:
- capital expenditure
- food or drink for consumption by the 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)
More importantly for most contractors, HMRC have also dis-allowed a number of services from its definition of ‘relevant goods’, and it is the exclusion of these items which will undoubtedly push many contractor companies (also known a service companies, managed service companies, etc) into the bracket of ‘limited company trader’. These services include:
- Contractor accountancy fees
- Advertising costs
- Any type of electronically downloaded service such as a subscription to a professional magazine
- Any downloaded software
- Office rental costs
So if you are a Programme Manager on a long term contract with a retail bank, and your annual expenditure is typically comprised of accountancy fees, a new laptop, subscriptions to relevant project management software and a monthly digital copy of “Project Manager Today”, then you are very likely to fall into the new category – what this means in tax terms is that under the old rules, on a turnover of £100,000, you will pay circa £2400 more in tax per annum from April 2017.
Should I leave the Flat Rate VAT scheme?
Before you jump ship to the standard scheme, here’s a few things to think about – in the above example, you are still making a net gain of £200 per annum over the standard scheme, plus the FRS was originally designed to make calculating VAT easier, and this is certainly still the case, especially if you incur very few business expenses. And if you’re just starting out, and are unsure which way to go, do remember that during your first year of VAT registration, your company will still qualify for the 1% deduction off the flat 16.5% rate, so it is still advantageous for new companies to join, even just for 12 months, as that will see you £1400 better off over the standard scheme in the above example.
If you are unsure whether the new rules apply to your business, make a complimentary appointment to visit the office with a copy of last years accounts, and we will ascertain which scheme will best suit your circumstances.