Flat Rate VAT schemes may not be the first thing you think of when you wake up. But following Chancellor Philip Hammond’s Autumn Statement this year, you may want to take a closer look if you’re a VAT registered small business.
VAT is a tax paid on most goods and services. VAT registered firms have to charge VAT on their sales and can reclaim VAT on their purchases. This involves careful record-keeping of all transactions and the rate of VAT they were charged at.
What is the Flat Rate VAT scheme?
To reduce the burden of this record-keeping on smaller firms, HMRC offers a Flat Rate scheme. With this scheme, rather than having to pay HMRC what you’ve collected in VAT on your sales less the VAT you’ve claimed for on expenses, you simply need to pay HMRC a set percentage of your sales. This means small firms generally don’t need to track VAT on purchases.
Why is it changing?
The growing numbers of self-employed were directly cited by the Chancellor as a cause for declining tax revenues, however, our experience and research shows that people incorporate for commercial reasons, not tax. The Chancellor clearly thought these VAT schemes were too generous and too many firms were using them. So, on top of the dividend tax hike earlier this year, we now have a VAT change.
How will Flat Rate VAT change?
From April 2017, the Government is introducing a new 16.5% Flat Rate VAT scheme that many ‘labour-only’ businesses, such as contractors, will have to move to. This will reduce some of the benefits of Flat Rate VAT for many self-employed firms, but it will still be more cost-effective than not being in the scheme.
Due to the way the Flat Rate scheme rates are set (e.g. 14% for management consultants), if you’re caught by the new rules you’ll end up paying more VAT (so a business consultant would pay an extra 2.5% of VAT).
Who exactly will this apply to?
A definition has been created of ‘limited cost traders’ who count as ‘labour-only’ businesses that will have to use the 16.5% rate if they want to use the Flat Rate scheme.
A limited cost trader is defined as one that spends less than 2% of its sales on goods (not services) for the period you submit a VAT return (HMRC call this ‘the accounting period’ for VAT only).
When working out the amount spent on goods, it cannot include purchases of:
- capital goods (such as new equipment used in a business)
- food and drink (such as lunches for staff)
- vehicles or parts for vehicles (unless running a vehicle hiring business)
If a firm spends less than £1,000 in their accounting period (if the period was a year), they also count as ‘labour-only’ even if this is more than the 2%. If your accounting period is longer / shorter than 12 months, the £1,000 threshold is pro-rated.
What should I do If I’m already on the Flat Rate scheme?
You should carefully compare your trading activity and costs against the definitions published by the Government. We await HMRC’s further guidance on this and will post further updates. In the meantime, you should consider setting aside funds to address any increase in your Flat Rate scheme level.
Flat Rate VAT Q&A
Our award-winning Senior Accountant Chris Barnard recently hosted a Facebook Q&A session to explain the changes further…
Q: Do I still get the 1% discount in the first year of VAT registration when on the Flat Rate scheme?
A: Yes – there is nothing proposed by HMRC that would mean this isn’t available.
Q: Has HMRC published a list of new Flat Rate sectors yet?
A: We’re not expecting any changes to the VAT sectors, however, you will have to apply the Limited Cost Trader test every VAT period.
Q: Will these tests be incorporated into the Crunch app? Are there any steps we will have to take (or info we have to provide to HMRC) ourselves before April 1st?
A: We’re assessing of all of our Flat Rate clients who are below the 2% threshold for applicable goods. We’ll be emailing these clients shortly to confirm we are moving them to the new VAT rate. Then, on an ongoing basis, we’ll review each VAT return, and an accountant will contact you if we believe that you are not a limited cost trader for that VAT period.
Q: The changes in VAT are for low-cost contractors. How can we avoid being classified as such and keep the current flat rate VAT rates?
A: The changes depend on whether you have any goods purchased in the VAT quarter starting April 2017. If the total of goods bought is less than 2% of turnover in the same period, then you’ll have to change rate.
Q: Is this rate change process handled by Crunch?
A: It is, yes. Currently, our developers are adding this rate into the system. This will be communicated to all of our clients.
Q: Currently, my trade sector falls under Printing, which is set at 8.5%. Can you tell me what this will rise to?
A: If you fall foul of the Limited Cost Trader test, the rate will be 16.5%. However under the Printing industry, I would expect this type of trade to have quite a bit of ‘applicable goods’. This could include the ink or paper for printing.
Q: So this new scheme decides if a business falls foul of Limited Cost Trader Test by analyzing the costs of purchases (only), that would be used by the business in one year… items such as Printer Toners or inks?
A: We’re waiting for finer clarity from HMRC on this, however, at this point in time we believe if the stationary and office supplies were used personally (for example at a home office) they wouldn’t be ‘applicable goods’. This means office supplies which are used solely for business, for either the trade of the business (such as a printing company) or used in a self-contained work office.
Q: Do we know yet if HMRC will change the rule on claiming VAT back once a year on items costing over £2,000. I’m thinking of purchasing a new Mac.
A: At this time we believe that the current £2,000 rule on reclaiming assets will remain.
Q: So given what you know now, can you give examples of items that would be factored in?
A: Cost of sales. For example, if you had a manufacturing business, the goods used in manufacturing would be included.
Q: Does the cost of a subcontractor count?
A: Unfortunately not – services are not included. We’re campaigning HMRC on this particular point.
Q: My company expenses consist of salary, accountancy, some travel costs, the odd subsistence expense, software rental, and telephone costs. How would I see if I currently meet or fall foul of this new test?
A: It’s likely you’ll be affected. Ultimately, the majority of service-based companies are likely to be affected by this. Here are some examples of items that won’t be included as applicable goods:
- Accountancy fees;
- Advertising costs;
- Hiring of equipment (this counts as services);
- Food and drink for you or your staff;
- Fuel for a car (this is excluded unless operating in the transport sector using your own, or a leased vehicle);
- Laptop or mobile phone for use by the business (excluded as it is capital expenditure);
- Anything provided electronically, for example, a downloaded magazine;
- Software you download;
- Bespoke software designed specifically for you (this is a service even if it is not supplied electronically).