How the Flat Rate VAT changes will affect a typical business

Posted on Feb 7th, 2017 | Tax

The Government has proposed making changes to the Flat Rate Scheme for VAT (FRS) which we believe unfairly hit small businesses. The Flat Rate VAT changes are due to come into force from April 2017. HMRC state that the aim of the new rate is to prevent abuse of the FRS system by employment agencies.

Whilst obviously opposing the illegitimate and bogus use of FRS, we fear that the planned changes are so broad that huge numbers of genuine FRS users will pay much more over to the Government in VAT.

To highlight the situation we’ve returned to the modelling we used for last year’s campaign on dividend tax changes. Our model is based on a typical limited company run by Jane, a sole owner/director with a total pre-tax income for her firm of £43,000 a year. Jane is in the IT industry and so is using the 14.5% IT consultant rate for FRS.

Before the FRS changes were announced this was how we modelled Jane’s tax burden up to 2020:



We could see the perverse march up a ‘tax hill’ for 16/17 before it slowly tails back down as corporation tax is cut and the personal allowance increases in coming years. By 2020 the burden is higher than it was in 15/16, but nowhere near the heights of 16/17 which is the painful dividend tax transition.

Now let’s run the same model for Jane in light of the proposed FRS VAT changes as announced in the 2016 Autumn Statement:



Now we see that the ‘tax hill’ has got higher, it keeps going up into 17/18 and the drop back by 2020 is much diminished. Jane’s company is paying £826 more tax for 17/18 and it doesn’t get much better in the coming years.

This happens because the costs the company spends on sub-contractors and other services (e.g. web hosting) are not considered as expenses in the new ‘limited cost’ test HMRC will require FRS users to apply every quarter. So physical goods and expenses count, but not services, despite services being the leading part of the UK economy!

Jane’s company will be considered a ‘limited cost trader’ by HMRC and so will be faced with a choice: Either switch from 14.5% IT consultant FRS rate to the 16.5% rate for limited cost companies, register for full VAT accounting or, because her turnover is below £83,000 a year, she could de-register altogether from VAT.

In the model, she is still very slightly better off staying in FRS VAT rather than de-registering but the choice will depend greatly on the nature of her costs going forward.

So these proposed changes add complexity to her business decision-making but also add costs. It can’t be right that an attempt to close a loophole ends up hitting a vast swathe of legitimate small businesses with higher costs and complexities. Was this really HMRC’s intention or an oversight, given that micro-businesses were not included in the impact analysis?

We’re talking to MPs to gain their support in fighting these changes, please join our campaign and contact your MP too!

Watch small business owner Paulo Estriga discuss the impact the VAT and dividend tax changes have had on his business:


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Written by Jason Kitcat

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