Small businesses to see changes to the VAT Flat Rate Scheme

Small business users of the VAT Flat Rate Scheme who have low costs may see the rate they pay drastically increase under new changes.

The Flat Rate Scheme was created to simplify businesses’ record keeping, by making it easier for smaller companies to figure out their bill. VAT is usually calculated via a two stage process, where VAT registered businesses are required to deduct the VAT on their inputs, from their outputs.

In comparison, the Flat Rate Scheme uses a simplified single step process, whereby they only pay VAT on the sale at a rate determined upon their business type.

Whilst this system is simpler for small business it can also lead to some businesses effectively paying less or more than they would do under the ‘typical’ two stage VAT regime.

HM Revenue & Customs has been aware of this inconsistency for some time and has long suspected some businesses of using the rules to their advantage.

With this in mind, the Chancellor Philip Hammond announced changes to the Scheme in the Autumn Statement, which will see the rate of low cost businesses, referred to as ‘limited cost traders’, increase.

Limited cost traders are one of the groups suspected of unfairly benefiting from the system. They can still use the Flat Rate Scheme, but their percentage will increase to 16.5 per cent. So if they sell £240 of work, including £40 of VAT, the flat rate amount payable is £39.60 or £240 x 16.5 per cent.

Businesses that spend less than 2 per cent of its sales on goods (not services) in an accounting period will be considered limited cost traders. A company will also be considered a limited cost trader if it spends less than £1,000 a year, even if this is more than 2 per cent of the firm’s turnover on goods.

When working out the amount spent on goods, it cannot include purchases of capital goods, food and drink or vehicles or parts for vehicles.

IT contractors, consultants, hairdressers and accountancy firms, which heavily rely on labour, with very little other costs, are most likely to be affected. Whilst construction workers who supply their labour, but are provided with the raw materials by the main contractor, are also likely to be caught up in the new changes.

The new rules will apply from 1 April 2017, but HMRC has warned that it may also affect invoices issued, and goods bought, from the date of the Statement onwards.

Link: Flat Rate Scheme for small businesses