The VAT Flat Rate Scheme (FRS) is designed to simplify the calculation of VAT due for small businesses. VAT is calculated by applying a predetermined flat rate percentage to the vat inclusive business turnover including standard, zero and reduced rate supplies. The flat rate is lower than the 20% standard rate of VAT but businesses can’t reclaim VAT on purchases except for certain capital assets over £2,000. The flat rates are determined according to the trade sector of the business and currently range from 4% to 14.5%.
The government considers that some businesses with ‘limited costs’ are obtaining too much advantage in using FRS as, although they correctly use the flat rate appropriate to their trade sector, they have significantly lower costs than most small businesses in that sector. So a new flat rate of 16.5% for certain businesses with limited costs will be introduced from 1 April 2017.
The government estimates that of the 411,000 businesses using the FRS, 123,000 have limited costs and will be affected by these changes.
A ‘limited cost trader’ is defined as one that
- spends less than 2% of its VAT inclusive turnover on goods in an accounting period.
- its expenditure on goods is greater than 2% of its VAT inclusive turnover but less than £1,000 a year.
Relevant Goods must be used exclusively for the purpose of the business and can include
- goods purchased as stock
- office supplies
- gas and electricity
- software provided by disk
Examples of supplies that are not relevant goods include
- advertising and promotional costs
- accountancy and legal fees
- subcontractor costs
- software downloaded
There will be exclusions from the calculation to prevent attempts to inflate costs above 2%. So some businesses will need to perform calculations to determine whether the trade sector rate or the 16.5% rate applies.
Those traders affected by the new rate could end up paying more VAT under the FRS than they would under standard VAT accounting.
The additional tax cost may result in some businesses choosing to:
- cease to operate the FRS, in which case you must notify HMRC, or
- opt to deregister from VAT altogether where they are under the VAT threshold.
Disclaimer: Please note that this document is not intended to give specific technical advice and should not be construed as doing so. It is designed to alert clients to some of the issues and not intended to give exhaustive coverage of the topic. Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein. March 2017
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