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.
To reduce the burden of this record-keeping on smaller firms, HMRC offers a Flat Rate Scheme (FRS). With this scheme firms simply pays HMRC a set percentage of sales, so they don’t need to track VAT on individual purchases.
HMRC has suggested that last year alone there were up to 30,000 bogus FRS applications made by employment agencies to profit from the financial benefits the scheme can offer. To prevent this HMRC has created a new definition of a ‘limited cost’ business (also called ‘labour only’) to try and catch these bogus enrolments and reduce the benefit to them of using the scheme.
From April 2017, the Government proposes 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 small firms, so 14% for a business consultant will become 16.5% if they fall under the new definition.
Geoff is an IT contractor running his own limited company and is registered in the Flat Rate Scheme for a VAT rate of 14.5% on all sales. His company earns £43,000 pre-tax income each year. From April 2017, because his main costs are services by sub-contracting some work to another consultant and travel expenses he is classified as a ‘limited cost’ business. So his Flat Rate Scheme rate goes up to 16.5% meaning his business is £826 worse off year on year.
What’s the problem?
On top of the 2016 rise in dividend income tax rates, this is another shock increase to taxes for small businesses who are the least able to absorb such cost rises.
Furthermore the definition for ‘limited costs’ businesses is too broad. It applies where a firm’s costs of goods are either: less than 2% of turnover; or greater than 2% of turnover but less than £1,000 per annum. It completely excludes services, so a firm dependent on using sub-contractors, no matter the value, will be hit by the change.
The Crunch view
In our view this is a deeply unhelpful move to add costs and complexity to small businesses at this sensitive time for the economy.
We believe the definition that the 16.5% rate applies to should be significantly revised so that it doesn’t hit huge swathes of completely legitimate small businesses. Yes HMRC should close a loop-hole that is being abused, but not in such a way as that most self-employed people are hit.
Write to your MP using WriteToThem explaining your concerns about this measure using the information on this page. The changes will be made by a Statutory Instrument which has been published in draft here.
Watch our case study video (above) of micro-business owner Paulo Estriga explaining the impact the VAT flat rate changes will have on top of the dividend tax rise and Brexit.